Friday, October 7, 2011

Saving the Euro

The fate of the euro will be decided over the next few weeks.

The key player in the drama - Germany - is conflicted over its desire to save the euro and its anger and irritation at having to bail out its more profligate neighbors.

Meanwhile, austerity measure proposed in Greece, Italy and other countries are drawing nationwide protests.

There have been any number of proposals on how the euro can be saved. I don't know which will be adopted - if any - but they all have one thing in common: they're going to require huge sums of money.

However, an article yesterday in the New York Times suggests that vast sums of money alone may not be enough.

Written by Peter Boone and Simon Johnson, the piece discusses one current proposal which suggests that a mere 4 trillion (!) euro bailout package should do the trick.

This is a mind-boggling number: the authors note that the GDP of Germany is around 2.5 trillion euro, so the bailout would involve either direct funds or guarantees totaling 50% more than the yearly economic of the largest economy in Europe.

Yet they also suggest that a massive bailout package may not save the day. Moreover, if additional funds were to be needed after the initial financial infusion, there is the real question as to when donor fatigue would set in, i.e. when would the German citizenry say, enough is enough:

Lech Walesa famously remarked that it was easier to make fish soup from fish than to do the reverse. So it is with fiscal crises — once fear prevails and markets start to think hard about the stress scenario, it is hard to solve the problem simply with reassuring words or financial support that never needs to be used....

Putting in place a huge financial package is not enough. Policies have to adjust across the troubled euro-zone countries so that nations stop accumulating debt, and the periphery moves rapidly from being among the least competitive nations in the euro area to the most competitive — and this includes lower real wages, even if debts are restructured appropriately.

The European leadership is a long way from even recognizing this reality, let alone talking about it in public.

In other words, even if a massive bailout package is announced tomorrow, it is not clear that the eurozone will be saved unless fundamental changes are enacted.

Interesting thoughts going into a long weekend.