Photo: Charlotte McKnight on Flickr
Today’s announcement by the International Monetary Fund that it would offer massive credit lines to sovereigns targeted by external shocks sparked a brief market rally, but any momentary confidence behind that move has faded—and for good reason.In reality, today’s proposal changes nothing for Europe. The onus of “fixing Europe” still rests squarely with the European Central Bank and EU leaders.
It is easy to immediately point out a handful of flaws with the new IMF plan:
- There is no way that the IMF can actually back the debt of a sovereign like Italy. Regardless of how much it’s promising to lend, it doesn’t have the funds in its arsenal. The IMF’s current free resources amount to around $540 billion. Italy’s gross external debt is over $2.2 trillion.
- The IMF is not likely to get approval from the U.S. (its primary backer) any time soon to expand its resources.
- Even if the IMF could contribute its remaining funds to the European Financial Stability Facility—the eurozone rescue fund—this still probably wouldn’t be enough to stem the tide of contagion in Europe.
Meanwhile, the European Central Bank and German Chancellor Angela Merkel have categorically rejected ideas like the issuance of eurobonds and large-scale sovereign bond purchases by the European Central Bank.
But if the euro is to survive, there is simply no choice but to take some combination of these drastic measures.
Spanish and Italian borrowing costs are nearing unsustainable levels. Today, yields on 10-year government Spanish bonds topped 6.6% at their highest close ever. Italian bonds continue to hover around 7%, despite having fallen from levels hit a few weeks ago. Now that pressure is steadily mounting on AAA-rated France and Austria and AA+-rated Belgium.
There is no end in sight to these rising borrowing costs, particularly with funds becoming tighter for banks. Austerity measures and spending cuts are too little too late to convince investors that these are sure-bet assets—the only reason most investors would buy sovereign bonds in the first place.
Truly “kicking the can down the road” as EU leaders have been doing so far—denying the severity of the problem and enacting a band-aid of a solution—is no longer enough to satisfy markets. Traders will continue to bet against the euro and the PIIGS periphery unless EU leaders can assure them they have no more reasons to be fearful.
True, the two options on the table right now are last-resort policies for Germany and the ECB. But let’s face it, Germany will never agree to more fiscal integration unless it’s under the gun, nor will the eurozone truly be disciplined without the profitable core positioned to lose out from runaway spending.
Even if Germany were to advocate a smaller eurozone (not the current policy), its back will soon be up against the wall. With France’s credit rating under fire, Germany now stands to threaten the stability of the core if it continues to draw out the debt crisis.
We can count upon Germans to finally acquiesce to unpopular demands like eurobonds and ECB involvement, but only when their backs are up against the wall. Germany’s losses if the euro fell would be enormous and likely throw the globe into a recession, and no politician in the euro area wants to be responsible for killing the euro. The German Council of Economic Experts is even endorsing eurobonds now—a good sign for the direction of policy.
Germany and the ECB still have the tools available at their disposal to stem the euro crisis. It would behoove the rest of the world to call their bluff and make sure these tools are utilized as quickly as possible.