Another week, and another meeting of European finance ministers – this one in Budapest to deal with the Portuguese debt crisis. Despite underlying problems that are not being properly faced across Europe, the news that Portugal was seeking financial assistance was met with barely a reaction.
Indeed, the euro rose in value against the U.S. dollar, because markets interpreted bad news about inflation as representing good news for the exchange rate. Meanwhile, the sovereign debt problem in Greece is only on hold. Ireland, the third country seeking financial help in a year, is still not out of the woods; its new government must simultaneously contend with its predecessor’s bad decision to bail out banks while renegotiating European Union assistance.
Why did markets not react to Portugal’s announcement? Financial markets, if not most observers, thought a bailout was inevitable.
Already some are wondering whether Spain is next, with possibly Italy and Belgium waiting in the wings. It’s beside the point that economic and political conditions in Spain are different – on the basis of its more sound economic fundamentals, a request for assistance from the EU or International Monetary Fund seems unlikely. Financial markets do not always take their cues from mere fundamentals.
Despite brave attempts in several euro states to restore fiscal probity, and demonstrate action to restore confidence in economic governance, there is no escaping the unpleasant arithmetic of interest rates. Interest costs far exceed many economies’ capacity to finance their debt through growth.
In addition, as demonstrated in April by the European Central Bank’s rate increase, inflation is not the exit strategy likely to be adopted to reduce debt burdens. The better-off European countries or EU partners, if not the International Monetary Fund, will be asked time and time again to make loans to prop up the sovereign-debt management strategy, whose only sensible outcome is a form of debt restructuring.
So far, however, debt restructuring is considered unthinkable. EU leaders shudder at the thought that one of their members might be lumped together with countries that have previously gone down the sovereign-debt restructuring road, such as Argentina in 2002. South America is the region of the world most associated with episodes of sovereign debt restructuring.
An inability to face facts is the strategy currently followed because domestic politics apparently precludes such an approach. European political leaders instead hope that financial markets, and the public, will believe that the recently agreed-to European Stability Mechanism will be adequate to resolve any future crisis.
The fact that the new stability institution will not be in place until 2013 is the least of its problems. Another one is that it is riddled with flaws.
Paid-in capital for the new institution will be small, with any additional capital provided via guarantees. This creates the potential for one member state having to help out another member which has misbehaved financially, with collateral fiscal damage that is likely to be politically unacceptable — setting up the system for precisely the kind of crisis that very nearly wrecked the global financial system in 2008.
As noble as the European experiment has been, and one needs to acknowledge its successes, there comes a time when the governance structures that served a region so well need to be reconsidered.
European leaders have failed to properly deal with the issues. They insist on complete autonomy in fiscal policies, spending as they wish, while their single monetary-policy authority is being pushed into adopting policies beyond its mandate. This cannot continue.
Pierre L. Siklos is a senior fellow with the Centre for International Governance Innovation, a professor of economics at Wilfrid Laurier University, and director of the Viessmann European Research Centre.