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Europe's leaders seem finally to have risen to the occasion in their crisis management, as they put together something genuinely BIG over the weekend to support the financial stability of the eurozone. It was quite literally the first "2 a.m. Sunday morning moment" for Brussels (albeit a little after the markets opened in Tokyo and Sydney) and for European Union leaders as they groped for a credible solution to allay the concerns of financial markets.
Details remain scarce, but headline numbers are as follows [PDF]:
- €60 billion from an EU community fund (i.e., funded by all 27 member states under article 122.2) to support financial stability in Europe as a first line of defense;
- €440 billion from eurozone members in bilateral loans or guarantees also going toward financial stability in Europe with all eurozone members participating; and
- up to €250 billion from the International Monetary Fund (IMF)—i.e., 50 percent of the eurozone commitment—toward financial stability in Europe;
A total of €750 billion in funds is available for eurozone countries that get into financial problems—that is genuinely big and would potentially be sufficient to shore up a country even the size of Spain. All these funds would be available to the recipient country under IMF conditionality, eradicating any notions that regional lending would be on more concessionary terms than that of the IMF. Moreover, it is now clear that IMF conditionality and direct influence over fiscal and economic policy more broadly is applicable for the entire eurozone. (How the mighty have fallen! Perhaps the United States should take note, in case the deficit commission doesn't make any progress.)
Moreover, and at least as important, the European Central Bank (ECB) again reversed itself and agreed at the level of its governing board to intervene in the secondary market for "those market segments [that] are dysfunctional," essentially acting as a lender of last resort for eurozone countries and financial institutions under stress, a functional equivalent of a quantitative easing move by the ECB.1
This real volte-face by the ECB—and one that according to the ECB president did not have unanimous support on the governing board (a good guess would be that the German members from the old Bundesbank dissented)—was its signal of broad willingness to do "whatever it takes" to secure the financial stability of the entire eurozone. This step, far beyond a narrow commitment to price stability, marks the emergence of the ECB as a genuinely pan-European central bank. It reflects the bank's concerns about the stability of the entire eurozone—rather than simply its focus inherited from the old inflation-fighting Bundesbank. The significance of the move is hard to understate.
The agreement over the weekend also secured political commitments [PDF] from the Spanish and Portuguese governments to "take significant additional consolidation measures in 2010 and 2011," accelerating their path toward fiscal rebalancing. Particularly for the Spanish government, this represents a dramatic shift in attitude. It has now committed itself to cutting the budget deficit by an additional €15 billion by 2011 (an extra 0.5 percent in 2010 and an extra 1 percent in 2011). The Portuguese government committed to an additional 1 percent of GDP reduction in its deficit in 2010. Both countries also committed themselves [PDF] to presenting new "structural reform measures aimed at enhancing growth performance."
This represents good news, as Europe finally seems to have awakened to the severity of the crisis. The measures effectively address the two major channels of contagion from the Greek crisis: (1) through the European banking system, now effectively insulated; and (2) the threat of contagion to other weaker eurozone members, in particularly Portugal and Spain. The financially weaker eurozone countries now have a fall-back option based on IMF conditionality and a chance to prove to the markets that they are not the next Greece.
Two questions remain: What about Greece itself? And who pays?
First, regarding Greece, it is important to note that this deal has nothing to do with that country or its longer-term solvency problems. If anything this deal could accelerate austerity and deflation in other eurozone countries, hurting Greek exports.
By guarding against contagion from Greece, this deal ironically makes a Greek default less risky and unpredictable, possibly increasing the likelihood that Greece and its creditors will agree eventually to the inevitable organized debt restructuring, perhaps as early as six months from now. If this deal facilitates dealing with potential "eurozone rot" stemming from Greece, it will have been a success. But it has the added benefit of making it less risky for Greece and its creditors to bite the bullet and deal with Greece's fundamental solvency problem.
Second, the issue of who pays what in the overlapping tranches of this deal, the EU-27 as a whole will split the cost of the €60 billion of the EU budget–based financial safeguard measure. The implication of that division is that all 27 members will pay through their share of the EU budget charged to member states.
In addition, eurozone members will share—most likely according to their share of the paid-up capital of the ECB—the cost of the €440 billion pool of bilateral guarantees. Finally, the entire IMF membership will share the potential cost of the up to €250 billion commitment according to their national quota share in the fund.
View table in euros [PDF] or in dollars [PDF].
Table 1 illustrates how the potential costs of this plan's commitments break down by eurozone members and the IMF. Note that table is approximate and does not account for the fact that the countries receiving aid would not participate in the cost of their own rescue package. Were this country to be Spain, it would imply that an additional $79 billion to be redistributed among the other members of the eurozone, EU-27, and IMF.
Several things are clear from table 1. For Germany, the package represents a truly large potential total commitment of $187 billion, or an additional 6 percent increase in Germany's total general government debt. The respective numbers for France and Italy are $143 billion and $122 billion. This is a large commitment especially for Italy, which already has a very high total debt stock and makes the ultimate political credibility of this commitment somewhat suspect.
It is also clear that non–EU 27 countries with $216 billion in potential commitments through the IMF share a substantial part of the bill. The United States as the largest shareholder leads the way with $55 billion, Japan with $20 billion, and China with $12 billion. This is hardly pocket money. Moreover, as the IMF has a global membership, assisting countries like Greece, Spain, and Portugal means a potential net wealth transfer from poor to rich countries. As can be seen in table 1, this would represent $9.2 billion in potential commitments from the world's poorest nations, $56 billion from middle income countries, and $127 billion from countries poorer than Greece.
The political implications of these potential transfers are likely to be large, especially if they are seen to be driven by Europe's last—and highly activist—managing director of the IMF, Dominique Strauss-Kahn of France.
The costs of containing the latest Europe-based episode of the global crisis will thus be shared globally.
Notes
1.The ECB has also announced a series of full allotment open tender longer-term refinancing operations and re-activating together with other major central banks the temporary liquidity swap lines between them.
