28 October 2012

Wolfgang Münchau: Crutches prop up euro, but it's still lame

If you step back from the latest events and consider the bigger picture, writes Münchau in his FT column, you always come back to the same questions. Is this a liquidity crisis only – in which case the measures taken should be sufficient? Or is it a solvency crisis?

Eurozone governments' determination to stop the liquidity crisis is matched only by their refusal to recognise the solvency crisis. The ECB and Member States may be infinitely patient in rolling over debt, but unwilling to recognise losses, for example on Greek sovereign and on Spanish banking debt. I was reminded of that when I read that Germany was now ready to accept a two-year extension of the Greek programme, but there would be no new money, leaving Greece itself to fund the gap – something that is simply not going to happen. The refusal to let the European Stability Mechanism fund Spanish banks directly falls into the same category. Debt that has arisen in Spain will remain debt of the Spanish state as ultimate guarantor.

Resolution means policies to assure a return to solvency. Solvency is an analytical concept, which itself depends on your assumptions about interest rates and economic growth and, of course, the total burden of debt. If you make unrealistically optimistic assumptions about the size of the fiscal multiplier, the global economy and the impact of structural reform on growth, you can make any debt disappear on paper. This can go on until these assumptions are falsified. But it cannot go on for ever.

The latest dreadful confidence surveys are in line with my expectation that austerity will have a very significant negative effect on growth in 2013. The recession in southern Europe, including Greece, will probably continue at least until 2014, at which time debt to GDP ratios are likely to be similar to today’s. If you keep piling austerity programme on austerity programme for a sufficiently large number of years, then the policy might eventually work. But that’s a politically unrealistic proposition. Portugal, for example, is already cutting subsistence payments for very poor people to meet the agreed deficit targets.

I believe therefore that crisis resolution still has to happen, but I see no evidence that we are getting there, not even in small steps. I do not expect any change in this situation even after the German elections. Since the crisis is not going to resolve itself, I cannot see any fundamental change in the situation – except that the ECB has removed the risk of accidents in the short term.

© Financial Times