De Grauwe writes that the only way to end the eurozone crisis is to convince financial markets the euro is here to stay. And that means a credible form of debt pooling.
It is important to underline one of the main design failures of the eurozone because this can tell us what exactly has to be fixed. Eurozone governments issue debt in euros, a currency they cannot control. As a result, and in contrast to “stand-alone” countries like the UK, they cannot give a guarantee to bondholders that the cash will always be available to pay them at maturity.
The fact that eurozone governments cannot give such a guarantee to bondholders makes them vulnerable to distrust and fear in the bond markets. This can trigger liquidity crises that in a self-fulfilling way then drive countries towards default, forcing them to apply austerity programmes that lead to deep recessions and ultimately to banking crises. This is not to say that countries which have overspent in the past don’t have to apply austerity. On the contrary, they most certainly will have to. It is rather that when financial markets are driven by panic that forces austerity on these countries with such intensity that it can trigger major social and political backlashes that may be uncontrollable. We can now see precisely these effects in a number of southern European countries.
This diagnosis of the eurozone’s primary design failure leads us to the idea that some form of pooling of government debts is needed to overcome this flaw. By pooling eurozone governments’ debts, the weakest are protected from destructive movements of fear and panic that arise in the financial markets of monetary unions, and that in theory can hit any member country. Those that are strong today may become weak tomorrow, and vice versa.
Not just any type of pooling of national debts is going to be acceptable. The major concern of the stronger countries that are asked to join in such an arrangement is that of moral hazard, i.e. the risk that those who profit from the credibility being conferred by the strong countries then exploit this and relax their efforts to reduce their debts and deficits. This risk of moral hazard is the single most important obstacle for pooling debts in the eurozone, and the second obstacle is that inevitably the strongest countries will have to pay a higher interest rate on their own debts as they become jointly liable for the debts of governments whose creditworthiness isn’t so great. In other words, debt pooling must be designed in such a way as to overcome these obstacles.
The article is published in the Spring issue of Europe's World.
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