Today's date:
Winter 2011

The Long-term Solution for Europe

Jacques Attali, founding president of the European Bank for Reconstruction and Development, now heads PlaNet Finance. Haris Pamboukis is minister of state to the prime minister in Greece.

Paris—Since the outbreak of the Greek debt crisis, Europe has tried to fix its problems in a stopgap and short-term manner. Not surprisingly, the crisis has continued to widen, threatening not only the individual economies of Ireland and Portugal and possibly Spain, but the European project itself. It is time to address the crux of the matter with systemic change before it is too late.

As it stands now, Europe’s member states have had no choice but to put themselves at the mercy of the financial markets.

The growing needs of modern states have pushed them to borrow increasingly, using ever more risky and sophisticated instruments. Investors have historically bought this sovereign debt because it has been a relatively safe haven. Unlike corporate debt, public bonds imply a guarantee backed by the state’s tax base.

Yet, just as states create markets which allow them to finance themselves, those markets can turn against the state when the extent of a country’s borrowings leads to doubts about its ability to honor its commitments. As we’ve seen, this can lead to a mortal duel between these two stakeholders, each of which warily watches the other’s moves very carefully as they try to protect their interests.

This is the situation in which Europe finds itself today. The only way out of this dilemma is to restore investor confidence. And that is only achievable by defining a credible path toward the return of sustainable public finances in Europe as a whole.

The Euro is not in danger in the short term. It is a solid currency based on the world’s largest integrated economy. However, the monetary union will not be able to survive in the long run unless something is done in the next few months to avoid a chain reaction of defaults among countries in the euro zone.

The worst-case scenario is all too easy to envision. The most threatened countries will attempt to avoid a catastrophe by adopting austerity programs. However, these will prove to be insufficient to restore investor confidence and ineffective in repelling attacks by speculators, which drive up their borrowing rates. The default dominoes will begin to fall, one after another.

The banks and other financial institutions that have underwritten the devalued debt of defaulting states will fall in turn, causing the ruin of their depositors, pensioners and salary earners. The European Central Bank (ECB), in turn, will not be able to prevent this disaster. If it does try to do so—for example, by printing more money—the Euro will collapse.

This scenario can still be avoided if we act now before the dominoes start to tumble. The solution is quite clear. The ECB must be backstopped by a European fiscal authority with several indispensable instruments: the ability to issue European treasury bonds and raise federal taxes, and the capacity for decisive action at the European level.

The European Union is the only sovereign entity without the capacity to borrow in private markets by issuing treasury bonds. If we are going to build our way out of this systemic crisis instead of urgently plugging gaps, the European edifice must be put on a more solid foundation through the authorization of such bonds together with the creation of a European Treasury entrusted with their management. The budget for this institution would be funded by its borrowings and by taxes.

In this way, the European Union as a single entity could assume a part of the public debt of its member states, up to 60 percent of its total GDP.

At this time, the EU is entirely debt-free, which gives it a considerable margin of maneuverability. The loan-service costs of the new EU treasury bonds would be lower than the costs of the bonds issued by individual member states. Member states could transfer to the Union the funds necessary to finance that debt service. As long as no such budgetary federalism exists, the common European currency—the Euro—will continue to become more fragile.

The present situation in Europe is far from new. History teaches us that sovereign debt crises usually seal a nation’s decline, especially if it has tried for too long to maintain its standard of living by excessive borrowing. Thus, the dangers of the present crisis for the future of Europe should not be taken lightly.

However, history also teaches us that, since its inception, and in each time of crisis, the European Union was always able to find a solution by taking the high road. First the common market and then the common currency were both born out of a common resolve to overcome difficult situations.

There is every reason to believe that again today, when push has come to shove, Europe will rise to the challenge.