European policymakers like to extol the strength of the eurozone: relative to the United States, it has a much lower fiscal deficit (4% of GDP, compared to almost 10% for the US). Moreover, unlike the US, the eurozone does not have an external deficit, which means that the monetary union holds enough savings to finance all of its members’ budget deficits and resolve their debt problems. But, despite this relative strength, the European Union’s leaders seem incapable of resolving the eurozone’s sovereign-debt crisis. Despite meeting after meeting, heads of state and finance ministers have failed to reassure markets. Now, Europe’s policymakers are appealing for help from the International Monetary Fund and Asian investors. This appeal for outside help is misguided, given the reasons why the euro crisis has gone from bad to worse, despite the EU’s abundant resources. The key problem is the distribution of savings within the eurozone. The countries north of the Alps have excess savings, but Northern European savers do not want to finance indebted Southern European countries like Italy, Spain, and Greece. That is why the risk premium on Italian and other Southern European debt had risen at one time to 5%, and why, at the same time, the German government can issue short-term debt at negative real interest rates. Northern Europeans’ reluctance to invest in their southern neighbors is the problem behind the problem. The German government could change this if it were willing to guarantee all Italian, Spanish, and other eurozone debt. But it is understandably loath to do so, owing to the high risk involved. The European Central Bank could also help solve the problem by agreeing to buy debt that has been shunned by financial markets. But, like Germany, the ECB understandably lacks enthusiasm about this solution. So the standoff continues, and the crisis worsens. The world’s major central banks recently agreed to make more dollar liquidity available, mostly to European banks. This has eased the immediate liquidity crisis, but the fundamental debt problem remains, because the Italian government cannot fund itself at reasonable interest rates. A month ago, the eurozone’s heads of state arrived at another way to appeal for foreign funds: the European Financial Stability Facility (EFSF) could package euro debt and sell it to foreign investors such as the Chinese and other Asian central banks. Here the same question arises: Why should China buy Italian debt when Germany shuns it? Even if China agreed to buy the debt, it would likely consider buying some of the special paper that the EFSF plans to issue only if it obtained some political concessions and an implicit guarantee from Germany. But it makes no sense for Germany to pay a political price for doing something – guaranteeing other countries’ debt – that it has consistently refused to do. The political concessions that China would probably demand – for example, EU recognition of the country as a market economy, or a greater voice within the IMF – may be overdue. Nevertheless, these issues should not be linked to the eurozone’s inability to solve its own problems. Moreover, a large inflow of funds from the IMF, China, or elsewhere could do more harm than good to the extent that it puts upward pressure on the euro’s exchange rate – and thus makes recovery in the crisis countries even more difficult. German growth could survive a stronger euro, because its exports are much less price-sensitive, but countries such as Italy and Greece, which must compete on price, would be weakened further. Europe’s policymakers cannot offshore the eurozone’s problems. Europeans can and must deal with this crisis themselves. One option discussed these days is a special fund, financed by the ECB’s major national central banks and placed at the IMF’s disposal to help Italy and Spain. This would harness the ECB’s resources without formally violating the EU’s Lisbon Treaty, which forbids central-bank financing for governments.
Daniel Gros is Director of the Center for European Policy Studies. A version of this article was first published on Project Syndicate.
