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While headlines in Europe are centered on a Greek exit from Europe, and the looming fiscal crisis, economist Jeffrey Sachs says Europe’s banking sector is the real imminent problem.In a Financial Times editorial, Sachs writes that in order to save itself, the eurozone needs to fight an ongoing collapse in its banking sector. He says the fiscal crisis can only be addressed after the region’s banking sector issues have been resolved:
“The Greek economy is collapsing not mainly from fiscal austerity or the lack of external competitiveness but from the chronic lack of working capital. Greece’s small and medium-sized enterprises can no longer obtain funding. Since 2010, Greece has been trying to stabilise a sophisticated modern economy while its banking sector is shrinking dramatically. It just doesn’t work. The shutdown of Greece’s banking sector brings to mind the dramatic shrinkage of bank lending during 1929-33 in the Great Depression.
Europe’s banking squeeze extends beyond Greece. Overnight deposits have declined since mid-2010 in the banking sectors of several other eurozone countries, including Ireland, Portugal, and Spain. In response, bank lending in those economies has also been cut, causing the current double-dip recession. And the reduction of bank loans could easily intensify if eurozone banks now try to raise their capital-asset ratios by cutting lending rather than by raising fresh capital.
There is still no evidence that European authorities, and notably German politicians, recognise the priority of rescuing the eurozone banks, and especially the banks in Greece and other weak economies. The European Banking Authority is tightening capital adequacy standards without paying enough attention to the ensuing steep credit squeeze. The focus on budget cutting in these circumstances is not only misguided but tragically inapt. Governments cannot close their budget deficits if payroll taxation is plummeting because payrolls themselves are being deeply squeezed.”
He says for the eurozone to survive, the economic and monetary union needs to 1) re-establish working capital 2) re-capitalise the banks 3) push the ECB to be a lender of last resort for its banking sector.
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