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We have reached bifurcation point – the time to make a decision. If Greece were forced to abandon the euro, the eurozone would mutate from a monetary union into a loose single currency area. I would then expect a mass withdrawal of foreign investment, a credit crunch and a large sustained fall in economic output. There is no way the eurozone will survive this shock in one piece. The consequences of a withdrawal would also be catastrophic for Greece.
A fiscal union lies in the other direction. But if it is to save the eurozone, it should comprise the following four elements. Not all have to be immediately introduced, but eurozone leaders should commit to them.
First, a eurozone-wide deposit insurance scheme with an unequivocal guarantee that deposits will be repaid in euros even if the host country leaves the eurozone.
Second, a eurozone-funded resolution trust company with the power to force a recapitalisation of the banks – without national veto. It is vital that this includes all banks, not just the biggest, as the most vulnerable happen to be the second-tier banks, such as Spain’s Bankia. The trust needs to be accompanied by a further centralisation of bank regulation and supervision.
Third, a proper eurozone bond to cover a large portion of outstanding and new debt. It would require a partial transfer of fiscal sovereignty from the member state to the centre. Ideally, the new fiscal union should also have regulatory powers over labour and product markets.
Fourth, a change in the mandate of the European Central Bank to include specific responsibility for financial stability – and to make it explicit that the ECB faces no constraints on the conduct of secondary market operations in pursuit of its new mandate.
Points one and two would require legislation, but no change in the European treaties, and would need to be implemented right away. For points three and four it would be sufficient to state a firm intention now and initiate a treaty change process, which will take time.
At their dinner last Wednesday, European leaders may not have produced a resolution, but for the first time since the outbreak of the crisis, they have at least discussed actual measures of crisis resolution, including eurozone bonds and deposit insurance. On Wednesday night they paused to think. I consider that progress. The trouble is that they may have left it too late. It may not be possible to agree such a path in time, given the amount of opposition that has to be overcome.
[We are left] with the following choices: an immediate collapse if Greece leaves the eurozone; a direct resolution path to a fiscal union; an indirect path via an enlarged ESM; and a futile fudge.
My guess is that Europe’s leaders will try the latter. This, too, will fail, at which point they will reach the next bifurcation point.
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