Two Models for Europe

by Hans-Werner Sinn

Project Syndicate
December 29, 2011

Interest rates for public debt within the eurozone have spread once again, just as they did before the introduction of the euro. Balance-of-payment disparities are steadily increasing. The sovereign-debt crisis is eating its way from the periphery to the core, and the exodus of capital is accelerating. Since the summer, €300 billion, in net terms, may well have fled from Italy and France.

The printing presses at the Banque de France and the Banca d’Italia are working overtime to make up for the outflow of money. But this only furthers the exodus, because creating more money prevents interest rates from rising to a point at which capital would find it attractive to stay.

If Europe had the same rules as the United States, where the Federal Reserve’s regional banks have to pay the Fed for any special money creation with securities collateralized in gold, they would not create this much supplementary money, and capital flight would be limited. Instead, local printing of money is essentially aiding and abetting the exodus.

If the eurozone does not want to embrace capital controls, it has only two alternatives: make the local printing of money more difficult, or offer investment guarantees in countries that markets view as insecure.

The first option is the American way, which also demands that the buyers bear the risks inherent in public or private securities. The taxpayer is not called upon, even in extreme cases, and states can go bankrupt.

The second option is the socialist way. Investment guarantees will lead, via issuance of Eurobonds, to socialization of the risks inherent in public debt. Because all the member states provide one another with free credit guarantees, interest rates for government securities can no longer differ in accordance with creditworthiness or likelihood of repayment. The less sound a country is, the lower its effective expected interest rate.

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