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Europe Struggles to Craft Debt Solution, Amid Prodding From U.S.

September 16, 2011 at 12:00 AM EDT
In Wroclaw, Poland on Friday, European Union economic leaders gathered to discuss the economic crisis facing Europe. Jeffrey Brown discusses what's next for the eurozone with The Economist Magazine's Zanny Minton Beddoes.
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JEFFREY BROWN: And joining me now to fill in the picture is Zanny Minton Beddoes, economics editor for The Economist magazine.

Welcome back.

ZANNY MINTON BEDDOES, The Economist: Nice to be here.

JEFFREY BROWN: Now, what is it that Secretary Geithner is asking them to do? What would constitute strong measures at this point?

ZANNY MINTON BEDDOES: Well, I think he’s trying to get them to recognize the gravity of what they’re doing, to stop kicking the can down the road, and to actually come up with a comprehensive plan to solve the problem, which is what they haven’t done. They have been muddling through and muddling through and muddling through.

And I think he recognizes — he was there at the invitation of the Poles. And the Poles have the current presidency of the European Union. And I think the Poles are probably equally worried about this. They are not members of the eurozone. But the members of the eurozone have just been failing to get to grips with the kind of gravity of their problem.

And so he, I’m sure, was there trying to impress upon them behind the scenes this could really be a catastrophe, and you just need to get your acts together and solve it.

JEFFREY BROWN: Now, he did get a good amount of pushback, including a bit of, “How dare you come and tell us about debt and deficit?” and things like that.

ZANNY MINTON BEDDOES: I thought that was — the Austrian finance minister saying publicly that she thought it was peculiar that a man from a country which had a higher debt-to-GDP ratio than the European Union as a whole came to lecture to them, frankly, I thought that was somewhat rude and completely unnecessary.

I mean, the truth is that Europe has a very big problem. And it is a big problem for the world if the Europeans fail to solve it.

JEFFREY BROWN: But now let’s go into that. I mean, what — explain the divisions that still exist politically within Europe as to why they can’t move forward.

ZANNY MINTON BEDDOES: Well, I think there are two things go on. The first is that there is a classic governance problem, that even if they agreed on what to do, or even if they knew what to do, there are 17 countries that have to sign off on this. And so part of the problem is that individual, often quite small countries in the eurozone want different things.

So, for example, the Fins want collateral for any money that they’re going to lend to Greece, which is causing a lot of problems.

JEFFREY BROWN: Because everybody else wants it, too, if they get it, right?

ZANNY MINTON BEDDOES: Absolutely. Absolutely.

JEFFREY BROWN: Yes.

ZANNY MINTON BEDDOES: But the bigger problem, I think, is that there is no agreement within the eurozone on really what the problem is. Now, that sounds absurd.

JEFFREY BROWN: You mean going back to root. What is the problem? They still don’t know what that is.

ZANNY MINTON BEDDOES: Absolutely. What is the problem?

Well, I think that there is a sense that the prevailing narrative in Europe is that this is a problem of profligacy, that governments have been spending too much, particularly governments in the south of Europe, particularly the Greeks, but also the Italians and the Spanish they would throw in. The Mediterranean countries have spent too much, had too much of a party and they need a lot of austerity. They need to tighten their budgets. They need to cut back, and that is the solution.

JEFFREY BROWN: That is one narrative.

ZANNY MINTON BEDDOES: And that is one narrative.

There is another narrative which isn’t very popular in Europe, but which is actually what is going on right now, which is that there is a profound loss of confidence in financial markets about the safety of European assets, particularly countries like Italy.

And the reason there’s that profound loss of confidence is because the rules of the game have suddenly changed. For the past 10 years, there was an assumption, maybe a wrong one, but there was an assumption which the whole financial structure was based on that this was risk-free government debt, that countries wouldn’t be allowed to default.

And over the past two years, there has been a kind of vacillation of, will countries be able to default, will they be allowed, will they not be allowed? And the weird thing is that the Europeans have said of Greece, which is the one country that is manifestly insolvent, they said this country will not default.

And yet they then as part of their muddling through said, well, we’re going to create a structure that will after 2013 allow countries to default.

JEFFREY BROWN: And that lack of confidence in nations would then lead to the problems for the European banks.

ZANNY MINTON BEDDOES: Absolutely.

Imagine — if you were an investor now investing in Italian government bonds, and you’re not sure whether — how this thing going to be resolved, why on earth would you invest in them? So you would have in effect a kind of sudden stop, a sort of panic of people not wanting to get in, and then the European banks hold enormous amounts of European sovereign bonds.

So the banks look in very, very bad shape. And the banks are therefore unable to raise short-term funds from anywhere, and they rely very heavily on U.S. money market funds.

JEFFREY BROWN: Well, and to address that, as we said, yesterday the central banks, including the Fed, stepped in to open a window, I guess, to allow banks to — explain that briefly, and are there risks in that for the U.S.?

ZANNY MINTON BEDDOES: No, I think the risks for the U.S. are minimal.

And I think that what this shows is that you can — the central banks are much better at coordinating and getting things done. And you’re exactly right. What these central banks have tried to do is to create a mechanism for these banks that need dollar liquidity to get it.

And I think that is a very important part of the solution. But it is not going to be enough alone, because the reason people are worried about lending to the banks is that they are worried about the solvency of the banks. And the reason they’re worried about that is, they’re worried about a default on government bonds.

And so until you deal with the crisis of the sovereign bonds, if you will, you are just not going to solve this. You have to do several things. You have to recapitalize the banks, and you have to deal with this loss of confidence in the sovereign bonds.

JEFFREY BROWN: All right, Zanny Minton Beddoes of The Economist, thanks so much.

ZANNY MINTON BEDDOES: Great to be here.