Financial Times
October 12, 2011
The world wants the eurozone to act, to do something that impresses the financial markets, a “big bazooka”, as David Cameron puts it. Among the recommendations generally given are an increase in the size of the European financial stability facility; a debt-monetisation programme by the European Central Bank; standby arrangements by the International Monetary Fund; bank recapitalisation, and a once-and-for-all resolution to the Greek debt problem. No matter what you do, do it now, and do it big, eurozone leaders have been told.
This is unhelpful advice, and if followed, it would make the crisis worse.My argument is not about symptoms and causes. It is about financial stability. A big bazooka, without a simultaneous commitment to a fiscal union in the distant future, could turn out to be extremely destabilising.
When the EFSF was first agreed last May, it was supposed to be the big bazooka. A shock-and-awe strategy, as one analyst famously called it. But it turned out to be a crisis propagator. The fundamental problem of the EFSF is that everybody guarantees each other in a game of domino. Italy’s guarantees make up 18 per cent of the system. But this 18 per cent lacks credibility. Italy is hardly in a position to pay its own debt, let alone guarantee someone else’s. While France is healthier, its guarantees to Italy also lack credibility. And so do German guarantees for France. If you follow the line to the end, there is no ultimate backstop.
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