May 10, 2010
By Peter Boone and Simon Johnson
The eurozone self-rescue plan announced last night has three main elements:
1.750bn euros in a fiscal support program, with 1/3 coming from the IMF (although this was apparently news to the IMF).
2.The European Central Bank promises to buy bonds in dysfunctional markets.
3.Swap lines with the Federal Reserve, to provide dollars.
At first pass this package might seem to be in with what we recommended a week ago and again on Thursday.
But the European central banks have come in very early – with government bond prices still high – and there is no sign yet of credible fiscal adjustment for Spain and Portugal. The eurozone apparently did not even discuss the situation in Ireland, which seems increasingly troubling.
This is a whole new level of global moral hazard – the result of an alliance of convenience between troubled governments in the south of Europe and the north European banks (and implicitly, north American banks) who enabled their debt habit. The Europeans promise to unveil a mechanism this week that will “prevent abuse” by borrowing countries, but it is hard to see how this would really work in Europe today.
Overall, this is our assessment:
The underlying problem in the euro zone is that Portugal, Ireland, Italy, Greece, and Spain are locked into a currency which means they are uncompetitive in trade terms while they are also running large budget deficits. To get out of this they need large wage and price cuts to restore competitiveness, and they need to make fiscal cuts to get budget balances back at sustainable levels.
remainder in full:
http://baselinescenario.com/2010/05/10/eurozone-the-kitchen-sink-goes-in-now-it%e2%80%99s-all-about-solvency/
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