September 29, 2014

Debt forgiveness could ease eurozone woes

The eurozone debt crisis never went away. It merely acquired a misleading veneer of resolution thanks to grand promises, political chest-thumping and frazzled financial markets that were desperate to believe in happily ever after.

Today, there is an accentuated sense of deja vu (all over again, as Yogi Berra would concur). Europe faces the spectre of deflation. Some members, such as Italy, have toppled over the edge for the first time in more than half a century.

Germany threatens recession, and France is a basket case. Wages are in decline across club Med. Real hourly wages in Greece, Spain and Ireland recently fell for the fourth year in succession.

Bank lending, meanwhile, is an aspiration and Banco Espirito Santo is an ugly reminder of the iceberg of bad debts lurking.

Good Europeans are in decline while populism, nationalism and jingoism are les belles du jour. Enter quantitative easing (QE) as the white knight, as envisaged by the European Central Bank.

This is fast becoming a modern-day rain dance. QE is not a cure. It is a shot of morphine that sedates an ailing patient while doctors figure out what to do in the long term. As with most opiates, the patient feels elated and euphoric.

Leaving aside “niggles” like the Germans and the moral hazard of whose sovereign bonds to buy, there is no reason why financial markets should not rally if QE proceeds.

Our limited sample over the past few years proves this. Asset-price inflation and falling bond yields are, however, poor substitutes for long-run economic growth.

They are arguably even antithetical, given the punishing bubbles they risk creating. Europe has a singular problem.

It has far too much debt, and in a globalised world much of it is bound in a complex web, particularly among the weaker economies – namely Portugal, Ireland, Italy, Greece and Spain – and their main creditors: France, Germany, the UK and the US. Spain holds more than half of Portugal’s foreign debt claims, while Italy owes French banks about $373bn, almost a seventh of France’s GDP.

And, lest we forget, Italy also has the third-largest sovereign bond market in the world. This is a game of dominoes. Any solution that does not involve large-scale debt forgiveness is doomed to failure.

In the 1920s, the Dawes plan - an ambitious scheme of credit easing to tackle the intractable debts left by the first world war - fuelled an enormous bubble that ended in the great depression, as the underlying reality of sovereign insolvency became clear. It also created a fertile political climate for the nationalism that ended so disastrously more than a decade later.

Money is divisive when things turn sour. Here is a solution for Europe that tackles the root cause. Write down the debt – not piecemeal, as events force you discordantly to that realisation, but rather coordinated and on an ambitious Europe-wide scale.

This acknowledges that the system is saturated with debt, much of it bad, and restores the capacity for future economic growth. This is not unprecedented.

The Brady bonds are an earlier example that successfully tackled the seemingly intractable Latin American debt crises of the 1980s.

Europe needs its own Brady bond plan. Aggregate the debt, reduce principals and coupons, and allow the markets to price it free of political rhetoric and monetary smokescreens. Use QE, but as a salve to facilitate and ease the transition.

This allows creditors, public and private, to restructure to their preference while also providing debt forgiveness. It also buys the time needed for elusive structural reform to restore sustainable growth. Challenges remain.

All the core countries, notably Germany, must support it if market confidence is to be maintained. Terms and structures will need to be carefully thought out if Argentina-like problems are not to re-emerge. There are few other options on the table.

Without large-scale debt forgiveness, nothing will change. Rather, Europe will keep re-enacting the same tragedy of small decisions.

Japan may have stoically endured two lost decades, but it is far more homogeneous and united. Europe is not. Regardless of the end, it cannot sustain this journey without risking continued social tensions and an eventual emasculation of the Union.

theguardian.com

No comments:

Post a Comment