The European Financial Crisis:
Potential Solutions and
Consequences
PD Dr. Heribert Dieter
Staatsbankrott in Europa
Stiftung Wissenschaft und Politik, Berlin;
University of Warwick, United Kingdom
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PD Dr. Heribert Dieter
Overview
I. The creation of the monetary union:
optimistic assumption and contradictions
II. The failing crisis management
III. The immediate future: Selected defaults
Staatsbankrott in Europa
or further bail-outs?
IV. „Giant leap forward“ or „Back to prudent
policy“?
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
I) Monetary Union
European policy driven by overly optimist
assumptions: Default will never occur
No preparation for bankruptcy
Yet: regular feature of international finance
Since 1982: 70 cases of default
Since 1824: Over 250 cases, affecting 106
countries
1550 to 1800: Eight defaults in France
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PD Dr. Heribert Dieter
Staatsbankrott in Europa
I) Monetary Union
Walter Wriston (Citygroup) in 1979:
„Countries don‘t go bankrupt“
„Crises do not happen to us, here and now.
We are doing things better, we are smarter,
we have learned from past mistakes”
(Reinhart/Rogoff 2009, p. 1).
Contraction in monetary union: No bail-out,
but no default and/or departure from
eurozone
Invitation to test contradiction
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
I) Monetary Union
Countries and creditors: Refusing a bailout?
Belief in self-regulatory capacity of markets
Limits for government spending, but no
monitoring of private borrowing
And: confidence in fair play of members
Weak regulatory oversight, with hindsight:
too much trust, not enough control,
sanctions too weak
Key question: Who benefits from the Euro?
PD Dr. Heribert Dieter
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I) Monetary Union?
Staatsbankrott in Europa
Benefits from the Euro
Interest payments/ BIP 1994 und 2007 (OECD 12/2010)
Germany
2,6%
2,4%
France
2,9%
2,5%
Ireland
5,6%
0,9%
Portugal
5,9%
2,9%
Spain
4,4%
1,1%
Belgium
8,8%
3,7%
Italy
10,6%
4,7%
Greece
11,9%
4,2%
Effects: GR -7,7%; I - 5,9%, B - 5,1%
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
I) Monetary Union
Compared with 1994: Reduction of interest
rate payments of ~ € 18bn (Greece) and ~ €
88bn (Italy)
Opportunity wasted: neither a reduction of
government debt nor a surge in private
investment
Germany? Had German interest rates
Trade integration helped by monetary
union, but reduced transaction cost no key
factor
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
II) Crisis management
From early 2010: Crisis management fails
Failure to distinguish liquidity/solvency
Clear case: Greece not illiquid, but insolvent
German position: reluctant, but taxpayer
will make money from rescue package
No serious debate on other approaches
Word of the 2010: “alternativlos” (Merkel)
Yet: Alternatives existed
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
II) Crisis management
One: brutally liberal approach no help for
irresponsible countries and their bankers
Not applied: Fear of contagion
Two: Following Walter Bagehot
Last resort lending: “Lend freely, at penalty
rates, against good collateral”
Advantage: No interference in internal
affairs, ownership intact
Nationally created problems solved there
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PD Dr. Heribert Dieter
Staatsbankrott in Europa
II) Crisis management
Examples: US/Mexico 1994/95, Ger/Italy
1970s – successful help, sustained recovery
Not without risk: trust fund has to be
created, need for will to sell?
Road chosen: Liquidity against
conditionality – old IMF recipe
Problem: Too often failed, structural
reforms seldom succeed
Key factor: Imposed reforms face opposition
(in democratic societies)
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
III) Immediate future
Current picture: Greece facing default –
debt/GDP approaching 180 percent 2012
Only in Greece: opposition resisting change
Ireland in fragile recovery
Portugal perhaps facing default, but
political consensus
Spain: deflating bubble, well-managed
Italy: poor state, affluent citizens; crisis a
chance for change in post-Berlusconi era
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
III) Immediate future
Probably: Italy makes or breaks eurozone
Often ignored: Italians richer than Germans
Net financial assets 2011: € 60.800 vs. € 60.300
Including real estate: € 160.000 vs. € 130.000
Should Germany bail-out Italy? Why?
Can Italy solves its problems?
Assets: ~€ 370 bn in real estate only
No need to reward imprudent fiscal policy
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
III) Immediate future
Fear of contagion: Can be addressed
Likely: Default in Greece, liquidity
provision to other countries (ECB?)
Will banks manage? Positions in October
2011: Greek banks - € 49 bn, France € 9 bn Germany € 10 bn
Default in Greece no threat to financial
stability (outside Greece)
Probably necessary: re-capitalization of
weaker banks, in doubt by decree
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
III) Immediate future
Essential: default by Greece the exception,
not the norm
Not clear: haircut for taxpayers? And IMF?
Legitimacy: taxpayers oppose transfers
In Germany: 65 to 90 percent of voters
against any new transfers
Disconnect: MPs for, population against
Risk: European integration discredited, EU
seen as the problem, not the solution
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
IV) Europe in 2020
Current proposals: Further integration, giant
leap forward to USE
Fiscal policy supranational, sanctions and
control by Brussels
Appropriate for Europe?
Europe much more diverse than USA
In America: previously culture pushed aside
Diversity the strength, not the problem of
Europe: One size fits all not convincing
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PD Dr. Heribert Dieter
Staatsbankrott in Europa
IV) Europe in 2020
Consider: Not just tax rates, but also similar
tax collection?
And: Economic government would have
missed Spain and Ireland – private flows
Government debt 2007: 43/28
Political support for further integration: At
an all time low? Support in all eurozone
countries?
And: transfers (not liquidity provision) run
into constitutional obstacles in Germany
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
IV) Europe in 2020
Permanent transfers: Wrong incentives
Alternative: Back to Maastricht II
Two amendments: 1) Exit clause – societies
should have to option to leave
Internal devaluation too difficult?
2) Departure from unrestricted capital flows
Spain: required an instrument to stop real
estate bubble from inflating
Tax on inflows à la Brazil?
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PD Dr. Heribert Dieter
Staatsbankrott in Europa
IV) Europe in 2020
Potentially: Creation of incentives for
surplus economies – tax funding ESM?
Not discussed in Germany: The negative
dimension of current account surpluses
Mercedes/Lehman
Essential: nation state retains key authority
over fiscal policy
Flip-side: failure (and default) possible
Without clear incentives: limited future?
PD Dr. Heribert Dieter
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Staatsbankrott in Europa
Conclusion
Europe in troubled water
Greece a unique case
Other countries much better prospects
Can Greece default and stay in eurozone?
Sign of hope in many societies
Spain, Portugal, Ireland, (even) Italy –
considerable consensus on need for reform
Consolidation a medium-term strategy
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PD Dr. Heribert Dieter
Staatsbankrott in Europa
Conclusion
Will Europe succeed?
Doubts remain – crisis management
Not to be ignored: Competition for Europe
in Asia
Tusk: Poland
Churchill on USA
Thanks
PD Dr. Heribert Dieter
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