08 November 2011

Paul N Goldschmidt: The financial crisis - the moment of truth is fast approaching!

The only positive note seems to be a growing consensus over the fact that EMU (and EU) survival is unequivocally dependent on deeper economic and political integration. This inescapable conclusion has the merit of “clarity”. At the same time it puts European citizens in front of a stark choice: either the eurozone will disintegrate or it must transform itself into a “Federation” with a specific hierarchy of powers redistributed between federal, national and local authorities.

Disintegration of EMU would be a calamity for all 27 EU Member States – and the world at large. The insistence by the Prime Minister and the Chancellor of the Exchequer on the dire consequences for Britain of an EMU failure should be proof enough to deter any “Schadenfreude” by those who revel in the prospect of claiming “I told you so!” as they sink lock, stock and barrel into the depths of global turmoil. It is in the UK’s self interest to mobilise fully in support of the eurozone, preferably by joining it (together with the remaining nine non-Members), or at least by contributing to improve EU/EMU cohesion rather than aggravating divergences.

The chances of preventing disintegration seem to be fast diminishing as a result of the growing disaffection of the population which, as so often in the past, is tempted by nationalist and populist slogans that find a favourable hearing in times of economic hardship. This renders all the more difficult the implementation of the “federal” alternative which is the only truly viable option.

In order to survive, the eurozone needs access to the full gamut of economic and financial tools which are available to all “sovereign” states and which are sadly lacking within the incomplete EMU structure. The necessary measures include transforming the ECB into a fully fledged “lender of last resort” and the ability to conduct a proactive exchange rate policy in defence of EMU (and EU) Members' interests. In turn, implementing these changes requires acceptance of a profound restructuring of the EMU’s architecture and governance, with an appropriate centralisation of democratically-controlled decision-making, tempered by well-conceived devolution of powers in line with the principles of subsidiarity.

The event that prompted me to write at this time was the obvious “failure” of the EFSF’s latest capital-raising exercise which is germane to the negotiations underway to bolster its resources, and is emblematic of the existing highly dangerous situation.

Regardless of difficult market conditions, having to pay a spread of 177bp over 10-year Bunds for an “AAA”-rated issuer raises very serious questions.

Firstly, it shows the speed of the deterioration of the EFSF’s market acceptance (the spread was some 55bp last June), as reflected also in the low level of participation by foreign official bodies (Central Banks – SWFs). After all, they are already nursing considerable unrealised “paper” losses on their earlier purchases of EFSF paper.

Secondly, one should note that AAA-rated France pays “only” (today) 134bp over Bunds and is currently under “surveillance” with negative implications by rating agencies. This must mean that the EFSF may also lose its eminent status unless a profound restructuring of its credit structure is rapidly agreed upon.

Thirdly, it bodes ill for the capacity of the Fund to fulfil its prime mandate at a reasonable cost as it will need – appropriately – to transfer its increased funding costs to the “borrower”, reducing the benefit of the financial support commensurately.

Fourthly, it will be interesting to observe whether this negative development contaminates the market for the well-entrenched EU-guaranteed borrowers (EFSM- EIB), a potential danger that I have pointed out ever since the EFSF was created.

This is why I reiterate earlier suggestions which call for the following measures:

• Transform the EFSF (ESM) into a fully-fledged Agency of the EU benefiting from the EU budget guarantee (which implies the joint and several guarantee of the EU27). This would restore instantly the unquestioned credit status of the Fund and justify a significant tightening of the spread over Bunds at which its securities trade.
• Obtain that the EMU 17 counter-guarantee the EU budget against any call on its resources. Any call on non-EMU Members would be subordinated to a prior call on eurozone Members. With such protection, non-EMU Members, in particular the UK, should be willing to underwrite the EU budget guarantee. If this minimum level of solidarity is lacking, then it may be time to write off both the euro and the EU.
• Give the ESFS banking status with full access to ECB refinancing facilities.
• Merge, as a symbolic but strong show of solidarity, the IMF quotas of EMU Members into a single joint quota, represented by a single Governor on the IMF Board. This measure would also considerably strengthen the voice of the eurozone in this important Institution, as well as show the market the unflinching determination to do “all that it takes” to support the euro.

Recognising that these proposed measures will need time to be “fully” implemented, the announcement of an interim “unanimous political agreement” would go a long way to restoring market confidence and provide the necessary breathing space to overcome the fast-accelerating sovereign debt crisis. On the other hand, it would be foolhardy to believe that once the crisis reaches a point of no return, there will be time to “negotiate” the next steps to limit the effects of disintegration. There will be no alternative to implementing emergency measures including exchange controls, limitations of bank withdrawals and other measures reminiscent of the post-WWII period that most Europeans have never known. Such a situation would only prolong and aggravate the inevitable difficult period involving significant sacrifices that lies in any case ahead.

Paul N Goldschmidt, Director, European Commission (ret); Member of the Thomas More Institute

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Email: paul.goldschmidt@skynet.be                              Web: www.paulngoldschmidt.eu

© Paul Goldschmidt