Jim Flaherty, the Minister of Finance, was right to tell the Europeans on Thursday to take decisive action to deal with the euro zone’s sovereign-debt and banking troubles, which are unsettling the whole international economy.
The United States is essentially staying the course in its post-bubble, post-crisis deleveraging (the Federal Reserve’s “twisting” of the yield curve is good as far as it goes, but is not a cure for a languid recovery), while China is growing more slowly because of diminishing demand for its imports. The euro zone is now the area of greatest instability, the home of the world’s most dangerous economic fault lines.
The Europeans should stress-test – or, rather re-stress-test – all the euro zone’s significant banks, to discover the dimensions of the problem. The test results published in July were based on a stale-dated view of the creditworthiness of European governments – a bad case of circular reasoning.
This should be done with a view to a comprehensive rescue program – something like the Troubled Asset Relief Program in the U.S., the highly unpopular “bailout” of banks, which turned out to be much less expensive than was expected or projected.
So far, the European Financial Stability Facility is staving off a default by the Greek government, by covering shortfalls as they arise, and the European Central Bank is valiantly lending to various banks to keep them liquid, as needed. All this putting out of fires, one by one, if it continues, is likely to end up costing more than an ambitious plan – one that would consist of some combination of purchases of shaky assets held by banks and a recapitalization of banks by way of public-private partnership.
A wide-ranging European bailout plan would probably suffice if it had a budget smaller than that of the equivalent U.S. program. The politics, on the other hand, of the 17 euro zone countries are even harder than those of Washington, D.C.
But, as Mr. Flaherty said, “One wants to get ahead of the issue rather than react to a crisis.” If they truly try, the euro zone leaders can find a way to stop merely reacting and start preventing future crises. The world needs them to do so.