Zero hour for the euro

by Wolfgang Munchau

Financial Times
September 25, 2011

The world’s inability to shake off the economic downturn and contagion in Italy has changed the nature of the eurozone crisis. What was once a debt problem of small peripheral countries, is now threatening the euro’s existence. Europe’s leaders did not see this coming. They failed to recapitalise their banking system sufficiently. And when they designed the European Financial Stability Facility, they created a mechanism suitable only for small countries. Their strategy has come unstuck.

At the autumn meetings of the International Monetary Fund and the World Bank, eurozone policymakers came under an unprecedented degree of pressure to act. Will they?

On a purely technical level, the eurozone crisis can still be solved. A eurozone bond, flanked by a minimally sufficient fiscal union, would do it. Alternatively, the European Central Bank could extend its bond purchases programme to the same effect. Both steps would require fiscal and financial reform.

A more modest but effective proposal would be to strengthen the EFSF. Economists Thomas Mayer and Daniel Gros have proposed that it should attain a banking licence, so that it can draw funds from the ECB. Others have proposed that the EFSF could issue discounted bills. I have also heard a proposal to turn it into an insurance company.

The proposals have in common that the EFSF would be leveraged, so that it can operate beyond its notional ceiling of €440bn.

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