Barry Eichengreen:
Eurointelligence: [A]t this point the crisis boils down to just one word: Italy. Italy’s debt is too big to restructure and too big for the European Financial Stability to finance. While crises are complicated beasts, there’s no reason to complicate this one. Sure, Greece may have to restructure again. France may have to take budgetary measures. But those are sideshows. The euro area will not live or die on their basis. The euro area’s crisis is all about one thing: that Italy’s debt might be unsustainable....
Italy needs at least 1 per cent growth and 2 per cent inflation to ensure that the growth of nominal GDP exceeds the 3 per cent interest rate that is the best it can hope for. Bad economic news from other parts of the world has rendered 1 per cent growth unattainable. This, in a nutshell, is what caused the Italian debt market, and European financial markets more generally, to blow up. The budgetary measures that the Italian government has now proposed, moreover, will only diminish the country’s growth prospects. Raising taxes on financial investments and corporations will not encourage investment. The €13 billion of spending cuts and pension savings slated for the next 18 months will only depress demand further.
What would help would be radical liberalization of the system of national labor contracts. While the government is officially backing the idea, the only specifics we have is that any such initiative will be opposed by the country’s powerful trade unions.
Maybe Italy will shake off the deep structural problems with labor contracts, tax compliance, and company and administrative law as a result of which its economy has been unable to grow. Maybe 2012 will see the “miracle on the Mediterranean.”
If not, as seems more likely, and Italian growth slows, European policy makers will have two choices. One is a higher inflation target for the ECB.... The only other option is Eurobonds. Serious Eurobonds. Halfway houses, for example dividing sovereign debts into a first tier up to 60 per cent of each country’s GDP that will be guaranteed by euro area members as a group, and a second tier that will remain each nation’s responsibility, will no longer cut it.... [F]ull pooling of existing debts and having member states contribute to payments on it according to their respective GDPs....
Which distasteful option – inflation or Eurobonds – will be less revolting to German taxpayers? Your guess is as good as mine. (For what it’s worth, my guess is Eurobonds.) But the German taxpayer will have to choose. He is in a union with Italy. And there is no way he can get out.
And if the German taxpayer does not choose, then Great Depression II in Europe draws near...
