Irish voters approved the new euro-zone fiscal compact in a referendum that attracted 60.3 per cent of the vote, in a turnout of 50 per cent, confirming the country’s commitment to the path of fiscal consolidation that has to date witnessed GDP shrinking by more than 24 per cent from the pre-crisis level. Unemployment is stuck at 14.3 per cent.
Sounds like good news for Angela Merkel’s Radical Fiscal Diet club, no? Not really. If anything, the latest developments have amplified the evidence that Europe’s elites are endemically incapable of understanding even the basics of crisis management.
These realities are best exemplified by the events in Spain and Cyprus.
Spain has been at the doorstep of the intensive care unit for some years now. Yet, nothing is being done to foster the resolution of its banking crisis or to alleviate the immense pressures of it jaw-dropping 24.3 per cent official unemployment rate. At this stage, as is apparent to everyone save the eurocrats, Spain – just as Greece, Ireland and Portugal before it – needs not loans from the euro zone’s rescue funds, but direct Marshall Plan-like aid. Such aid should be linked to specific targets and come with strict conditions. But it must be debt-free.
On the other hand, Cyprus is a new entry to the euro area’s cardiac ward. In just under two months, the spread on Cyprus’s benchmark five-year credit default swaps have widened from under 1,130 basis points to almost 1,500, with the probability of a sovereign default rising to 72 per cent. The country second-largest lender – Cyprus Popular Bank – has written down by 74 per cent its holdings of Greek bonds. The writedowns are unfunded, and a call on the government is looming at the June 30th deadline for recapitalization.
Cyprus was already rescued once last year through a €2.5-billion ($3.1-billion U.S.) loan from Russia and is now in desperate negotiations with China to secure another bailout.
Cyprus’ descent into fiscal hell stands in sharp contrast to its relatively benign fiscal deficit (3.71 per cent for 2012 and expected to fall to 1.35 per cent in 2013); structural deficit (2.04 per cent in 2012, improving to a surplus of 0.39 per cent in 2013), and general government debt (expected to peak at 75.2 per cent in 2013). The only two drags are growth dynamics (with real GDP forecast to shrink 1.16 per cent this year before returning to 0.79 per cent growth in 2012), and the current account deficit (above 6.2 per cent of GDP in 2012-13).
The country is an example of banking sector contagion from the sovereign debt crisis; and its experience exposes the ineptitude of Europe’s leadership. This contagion has been fully predictable for at least 10 months since the writedowns on Greek sovereign bonds became calculable. As such, it is virtually identical to the cases of Spain (where banking sector deleveraging out of bad assets is now likely to cost euro-area rescue funds in the neighbourhood of €200-billion to €250-billion) and Ireland (where the bank collapse in 2008-09 triggered a €67.5-billion sovereign debt hike in 2010). What is required in Cyprus is the very same non-debt Marshall Plan. More loans – from Brussels or Beijing and Moscow – will not resolve the problem.
Europe is facing three coincident crises that reinforce each other and require a break of the contagion chain to first stabilize the regional economies and later address structural problems faced by its member states. These crises are:
· Long-term fiscal imbalances
· Structural growth collapse
· Immediate banking sector crisis.
Logic demands that Europe first break the contagion cycle, in which banking sector deleveraging is imposing severe costs on the real economy (government, household and corporate finances). Such a break can be created overnight by converting some of the EFSF and ESM funds into an EU-wide deposit insurance scheme, plus imposing an EU-wide hierarchy of banks’ debt drawdowns that will respect the existing seniority of debt holders.
Alongside the above measures, the EU must put forward a credible Marshall Plan, to the tune of €1.75-trillion to €2-trillion, funded by newly created money, not loans. The fund should disburse direct monetary aid to finance private sector deleveraging in Spain, Ireland and to a smaller extent, Portugal. It should also provide structural investment funds to Greece, Italy and Spain, as well as to a much lesser extent Ireland and Portugal. In Cyprus, the fund should be used to underwrite banking sector restructuring.
Constantin Gurdgiev is head of research with fund management firm St. Columbanus IA and lecturer in finance at Trinity College, Dublin.