Bailouts will not save the Eurozone

[girl gone mad]

Bailouts will not save the Eurozone
William Mitchell
http://bilbo.economicoutlook.net/blog/?p=9533

We are back onto Greece again today as the crisis deepens. Overnight Spain is appearing to be under bond market pressure and the Germans are calling for even harsher fiscal rules to be applied to keep member states “solvent”. The point is that none of the remedies being proposed will ultimately work. What is needed in the Eurozone is a major boost to aggregate demand. However, the policy direction is to further undermine spending in the member economies as austerity measures are being imposed throughout. This foolish reverence of the Stability and Growth Pact will worsen things. The problem in the EMU is that the basic design of its monetary system is flawed and the accompanying fiscal rules only accentuate those design flaws. None of the remedies being proposed by Euro leaders will work and the bailouts will not save the Eurozone. It has to fundamentally redesign its system or disband.

Paul Krugman’s recent blog – Default, Devaluation, Or What? – published May 4, 2010 raises some interesting questions about the current situation in the Eurozone.

Krugman notes the obvious – that the EMU bailout for Greece will fail:

Consider what Greece would get if it simply stopped paying any interest or principal on its debt. All it would have to do then is run a zero primary deficit — taking in as much in taxes as it spends on things other than interest on its debt. But here’s the thing: Greece is currently running a huge primary deficit — 8.5 percent of GDP in 2009. So even a complete debt default wouldn’t save Greece from the necessity of savage fiscal austerity. It follows, then, that a debt restructuring wouldn’t help all that much — not unless you believe that getting forgiveness on much of Greece’s existing debt would make it possible to take on substantial new debt, which doesn’t seem very likely.

This statement is only partially true. A complete debt default will not save Greece now under current institutional arrangements associated with its EMU membership, given its need to run on-going deficits.

However, default (or renegotiation of its Euro obligations into drachma) would help if it abandoned its membership of the EMU. Ultimately the way the events are unfolding the EMU will not be able to maintain its integrity without significant changes.

But it is true that under current institutional arrangements the bailouts will not work. They will have a short-term palliative impact only on the bond markets but cannot overcome the intrinsic dysfunction in the Eurozone structure which has led to this crisis.

The austerity packages that will accompany the bailouts will also make things worse.

http://bilbo.economicoutlook.net/blog/?p=9533">more...

[ixion]

1. Indeed. They didn't save the US, either.

You don't solve a debt crisis by going deeper into debt.

All we've done was make the Day of Reckoning worse.