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To save the eurozone, reform its governance: FT.com

Wolfgang Münchau
Financial Times
Monday 16 May 2010

The eurozone was never under speculative attack at any time. What happened was that investors, European pension funds among them, lost confidence in the system. And while fiscal profligacy was the root cause of the problems in Greece, it is not the root cause of the problems in Portugal and Spain. That would be a combination of a defunct labour market and massive indebtedness of the private sector.

But instead of solving those structural problems, the two countries last week responded with a fiscal tightening. What makes the economic problem in the Iberian peninsula so difficult is the simultaneous need to reduce debt and improve competitiveness. A reader wrote from Madrid last week that, in his estimation, the price level in his city was about 30 to 40 per cent higher than in Germany – as a result of which he orders all his durable goods from abroad. It is not surprising therefore that we are starting to see core price deflation as Spain cannot maintain a large price differential with Germany forever. If you add fiscal retrenchment into this toxic debt-deflation mix, the result is bound to be a self-sustaining depression, especially in the absence of structural reforms.

So when the European Union’s programme of credit guarantees ends in three years, the same combination of factors that led to the most recent crisis will still be present. The economic situation in Spain and Portugal will have deteriorated. And even if the Greek austerity programme works like clockwork, the country will still probably have to restructure its debt eventually.

What is completely missing in Brussels – and even more so in Berlin – is an understanding of the urgency of the situation. None of the governance reform proposals that are currently discussed even attempt to answer the questions of how Spain is going to get out of this hole, and how the competitiveness gap between the north and the south of the eurozone is going to be closed…

When I read the details of the rescue package, I thought it was ironic that a special purpose vehicle had been chosen to save the eurozone, given our most recent experience with those toxic structures. Come to think of it, perhaps not. They are the perfect instruments if a lack of clarity and transparency is the ultimate purpose. As the fog lifts we will notice that, despite the shiny new umbrella, not much will have changed.


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