Finance & Investing

Why Europe Needs a New Narrative

Can the eurozone fix itself in the absence of a catastrophe?

November 19, 2012

| by Edmund L. Andrews

Three years after it began, the European debt crisis casts a shadow over both the project of European integration and the global economy. The conventional wisdom is that there is no turning back. At a recent financial forum on Europe, hosted by Stanford GSB, panelists from both sides of the Atlantic outlined the challenges. Here are excerpts from their remarks:

Europe 2.0?

“Europe has a choice, a very dramatic choice, either to go forward and continue that drive toward more integration, or it can go backwards into some form of independent nation-states,” said Philipp M. Hildebrand, vice chairman of BlackRock, Inc. and a former chairman of the Swiss National Bank. But to continue with integration, he said, requires a “new narrative” on a par with European leaders’ postwar goal of a permanent peace.

But what narrative? Lorenzo Bini Smaghi, formerly on the European Central Bank’s executive board, said it was hard to offer a cheery vision for wrenching changes. But just as American conservatives often warn about the U.S. becoming more “like Europe,” Smaghi proposed, E.U. leaders might appeal to European worries about losing their safety net and “becoming like the Americans.”

On the “Fallacies of Credit”

Myron Scholes, the Frank E. Buck Professor of Finance, Emeritus, at Stanford GSB and a Nobel laureate, said Europe had to grapple with “three fallacies of credit.”

  1. If a country has trouble paying off debts, you want to keep lending it money to get the economy going.
  2. If you have cradle-to-grave entitlements and job security, people assume those entitlements are funded.
  3. Germany could prosper by ramping up exports to Greece and other “periphery” countries.

The truth, Scholes said, was that Germany had prospered mainly by “exporting money.” As Europe’s weaker economies fell into recession, Germany has stalled to almost zero as well.

On Financial Markets and Political Will

Peter Fisher, senior managing director, BlackRock, Inc., argued that bond markets are imposing an “ignorance premium” because investors can’t be sure what troubled governments, such as Spain, will do. “Will a country be paying its bills in euros or not?” Fisher asked. The possibility that a country will drop the euro, however low, gets “baked in” to bond prices. Vincent Reinhart, chief U.S. economist at Morgan Stanley, said one key problem for markets is the absence of a credible E.U. “commitment mechanism.” Even if leaders agree on a fiscal union, will the rules hold?

But Smaghi noted that the interplay between markets and political action is often “perverse.” Political leaders take action when markets signal a looming disaster, and markets calm down. However, as soon as markets settle down, political action stalls and markets soon panic once again.

A U.S. Model for European Banks?

European banking regulation remains fragmented, and many banks are in precarious shape. Many fear that tougher capital requirements would slow lending and economic growth even more. But Hildebrand of BlackRock suggested the opposite. “European banks need a recapitalization effort similar to what [Treasury Secretary Tim] Geithner did,” said Hildebrand, when the Treasury and Federal Reserve subjected big banks to stress tests and then used results to demand big capital increases. The result, Hildebrand argued, was a 15% increase in bank lending.

Keeping The Euro Viable

Peter Fisher, senior managing director and head of fixed income at BlackRock, gives his advice on how European politicians should handle the euro crisis.


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