Economix Blog: Simon Johnson: The European Debt Crisis and the G-20 Summit

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The April 2009 London summit meeting of the Group of 20 is widely regarded as a great success. The world’s largest economies agreed on an immediate coordinated approach to the global financial crisis then raging and promised to work together on banking reforms that would support growth. President Obama got high marks for his constructive engagement.

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The G-20 heads of government have met twice a year since then, and in Cannes this week they meet again. Could this meeting help stabilize the world economy? Can President Obama again play a leading role? The answer to both questions is likely to be no.

In 2009, the primary problem was slumping economies in the United States and Western Europe. It was in the perceived individual interest of those economies to engage in some fiscal stimulus – and they were happy to present this as a joint approach. China was also willing to stimulate its economy, as its policy makers feared that slowing global trade would reduce Chinese exports. President Obama’s appeal for fiscal stimulus around the world was pushing on an open door.

Now the issue is quite different. We have a sovereign debt crisis within the euro zone, in which countries that have borrowed heavily are facing the prospect of restructuring their debts. The euro zone summit meeting last week established that privately held Greek debt would fall by about half (relative to face value), although this does not clearly put Greece onto a sustainable debt path. Prime Minister Andreas Papandreou announced a plan on Monday for a referendum on the plan, a move with the potential to build political support for the needed reforms, and on Wednesday his cabinet offered its full support. But another outcome — if the government does not fall in the meantime, making the referendum plan moot — could be a Greek exit from the euro and a default on its debts in disorderly fashion, without any kind of international framework or outside financial support.

But the real issue is Italy, as it has been at least since the summer. The Europeans are only beginning to come to grips with the centrality of Italy in the European debt web – glance at Bill Marsh’s recent graphic to get the point. Italy has more than 1.9 trillion euros in debt outstanding; this is the third-largest bond market in the world. In the aftermath of the Greek referendum announcement, the yield on Italian debt rose above 6.1 percent. The standard view is that if this reaches 6.5 percent, Italy will need to seek assistance in the form of a backstop fund to guarantee there will be no default.

But the International Monetary Fund does not have enough resources available and the existing European Financial Stability Facility is also likely to be too small. People in the know talk of the need for more than two trillion euros in a “stabilization fund,” and while a lot of fuzzy math is involved in contemporary international financial rescues, the I.M.F. and the stability facility combined would be hard pressed to provide more than a third of that.

This might seem like a good time for a summit meeting – so the hat can be passed around among world leaders. And some people do hope that China can provide an enormous loan, either directly or working with the I.M.F. China, after all, has more than two trillion euros’ worth of reserves (not all in euros, of course; much of this is in dollars).

But it’s not clear China that wants to take the credit risk of lending directly – the Europeans might not repay, after all. And the United States is not keen to have China funnel such a large amount through the I.M.F.; this would undermine the traditional American predominance there. In today’s budgetary environment, there is no way that the United States can come up with anything like matching funds at a level that would make a difference – would you like to ask the House of Representatives for $100 billion right now to help keep Silvio Berlusconi in power?

And the heart of the problem is really European, not global. Specifically, the euro zone needs to address its underlying fiscal structure, which has become severely dysfunctional. It needs a proper fiscal union, with the right to tax and to issue debt – backed ultimately by the European Central Bank. And the ability of member governments to issue debt must be severely curtailed.

The United States faced a similar problem, long ago. The original Articles of Confederation proved inadequate, largely because there was no centralized fiscal authority. The Constitutional Convention convened in 1787 in large part because the United States had defaulted on its debts, incurred during the War of Independence – and there was no way forward without a new agreement among the original 13 states and greater fiscal powers (and more) for the federal government.

Europe needs the equivalent of a constitutional convention. But today’s financial markets move so much faster than 200 years ago, and the delay in Europe has already been excessive. The Europeans need to move fast. Will the Cannes summit meeting speed them up?

Article source: http://economix.blogs.nytimes.com/2011/11/03/the-european-debt-crisis-and-the-g-20-summit/?partner=rss&emc=rss