The European Union, the European Central Bank, and private-sector lenders have spent more than €1 trillion over the past two years, but the eurozone remains in no better shape today than in the autumn of 2009, when the full scale of Greece's fiscal problem was revealed. Meanwhile, the eurozone's recession is deepening and unemployment is rising.
Moreover, skepticism about the eurozone authorities' and leading powers' determination and/or competence to ensure the currency's viability is increasing systemic risk. For example, the European Investment Bank now inserts a drachma clause in its loan deals with Greek enterprises.
The same message is conveyed by the worries recently expressed by the Bundesbank with regard to the build-up of so-called Target 2 balances. In case of a breakup of the eurozone, these balances cause losses for the Eurosystem and member states' central banks. Indeed, many eurozone central banks reportedly have reduced their holdings of euro reserves, seeking to diversify into non-traditional currencies.
What caused the debt crisis, and how to resolve it, remain in dispute. What is clear is that a key factor has been the persistence of large imbalances within the eurozone -- current-account deficits on the periphery, mirrored by surpluses in the core -- owing mainly to differences in productivity and competitiveness. Excess savings have been transferred from the core to the periphery, creating conditions for extensive borrowing and accumulation of debt.
Debt growth exposed critical weaknesses in the eurozone's economic constitution: national debts are the responsibility of member countries, but the common currency is without a sovereign. Unlike most central banks, the ECB cannot act as a lender of last resort, which, in conjunction with the absence of common bonds (Eurobonds), induced large-scale speculation on intra-European national debts.
Resolving the crisis inevitably includes action on both fronts. The causes of the persistent imbalances should be addressed through a combined effort at fiscal consolidation and strengthened competitiveness, with structural reforms focusing on liberalizing markets and encouraging wage flexibility.
At the same time, the eurozone must be equipped with the instruments needed to restore stability and prevent the recurrence of crisis conditions. This agenda includes centralizing European debt through Eurobonds, mobilizing sufficient rescue funds, allowing the ECB to exercise the full range of central-banking powers, and reinforcing policy coordination in order to sustain economic activity in austerity-stricken member countries.
But sharp disagreements exist over the content and timing of the policy response. The weaker countries accept the need for reforms, but favor a longer time horizon for fiscal-deficit reduction in order to encourage a return to growth. They also demand faster implementation of the necessary changes to the eurozone's economic governance in order to create a more stable and hospitable environment for fiscal consolidation and reform.
A prolonged recession, punctuated by high -- or prohibitive -- borrowing costs, makes achieving either the fiscal or the reform targets increasingly difficult, if not impossible. The burden of adjustment cannot fall exclusively on the deficit countries -- unless, that is, a moral element of “punishment” is involved.
The core countries, led by Germany, distrust the over-indebted countries' determination to pursue reforms if their financing conditions are eased. Moreover, they oppose key changes in the eurozone's economic governance.
They could envisage the issuance of Eurobonds only after the completion of real economic and fiscal adjustment. They reject the use of ECB credit as a substitute for adjustment, because it would eventually fuel inflation. And they question the sustainability of economic and fiscal unification -- allowing transfers to the weaker countries -- in the absence of political unification involving loss of sovereignty.
If the stalemate persists, the debt crisis will soon reach new peaks. Continued recession and recurrent speculative attacks in the bond markets will prevent at least some over-indebted countries from attaining their adjustment targets, creating conditions for political crisis within the eurozone and individual countries. It will not be possible to postpone indefinitely strategic decisions concerning the euro's future.
It has been argued that in such circumstances, political will emerges, deus ex machina, and saves the day. But it is preferable to avoid reaching that stage.
As the crisis develops, accidents may happen that authorities find hard to control. Moreover, in some quarters of Europe, the euro's survival is viewed as requiring a cull: its membership should be reduced to those countries with convergent economic structures and performance, notwithstanding the enormous economic and social disruption that would be unleashed, or the heavy blow to Europe's global influence.
Given Europe's current political balance, and taking into account its time-honored tradition of muddling through, the following stand out as minimum requirements for steering clear of the precipice:
* A commitment to issue Eurobonds at a fixed date in the near future, as well as setting in motion the legal process for doing so. This would bring down borrowing costs for over-indebted countries and support economic activity.
* Implementation of a Marshall Plan-type initiative to finance investment in the weaker countries. Mobilizing resources in the EU budget and significantly increasing the lending capacity of the EIB would counter the recessionary effects of austerity.
* Relax deficit-reduction targets for countries particularly hard-hit by recession, while easing monetary policy as much as existing rules permit. Higher German inflation is part of the adjustment process.
A growing chorus of European and world opinion is pushing in the direction of more growth-oriented policies. The resistance will be strong. Time, however, is running out. The next few months are critical for the eurozone's future.
Yannos Papantoniou was Greece's Economy and Finance Minister from 1994 to 2001. He is currently President of the Center for Progressive Policy Research, an independent think-tank. Copyright: Project Syndicate, 2012.