Essay about the European Debt Crisis

Euro is the Europe's most significant monetary reform since the Roman Empire.The Euro is the form of currency used by the ever evolving Eurozone countries and consists of countries from the European Union and they figured out using a common currency which is the only legal tender money around the Eurozone.

The Euro was officially introduced on January 1, 1999. The idea behind this common currency get back decades ago, historically Europe was one of the worlds largest trading regions was complicated by fragmented currency, the league of Nations contemplated economic and monetary union.

However, World War II rail those ambitions and during the Cold War, efforts was made to strengthen ties between non-Communist nations and on May 1950 Paris treaty linked Belgium, France, West Germany, Italy, Luxembourg and the Netherlands and created the European Coal and Steel Company which six links the early economic community which was a precursor to the European Union Yankee of Economic Cooperation resurfaced a report published in 1970 suggested decentralization of financial policies in Europe this set the wheels in motion for a single European currency and Central Bank in 1979. Most of the EEC nations instituted the European monetary system to stabilize exchange rates and offset inflation of the new re-created European currency unit for much of the 1980s was realistically planning the establishment of the economic and monetary union 1986 is single European collaboration between EEC nations in terms of politics and economics.

The Maastricht treaty was signed February 7, 1992 and it was the support the community European Union it also established 1999 as a deadline for the creation of common currency and the basis for the shared financial strategy countries are required to meet stringent criteria in order to sign the agreement low budget deficits and debt ratios are just some of the required measures the groundwork for the euro.

During the 1990s European monetary Institute replace the EMCFor the European Multilateral Clearing Facility N.V. was Europe's largest cash equities clearing company and one of the top two Central Counterparty (CCP) clearing providers in Europe. in 1994 and became the prototype for the European Central Bank.

The currency’s name was finalized as “EURO” In December 1995 as many countries endorsed it to their populations but, United Kingdom, Denmark and Sweden eventually decided to opt out of its use and kept their own currencies each participating nations currency was converted to the euro via triangulation and negated discrepancies between the various countries standards surrounding an important numbers was finally determined in December 1998

EURO was first circulated on January 1, 1999 in non-cash transactions and accounting for example travelers checks and mortgages are all available in euros in national currencies of the euro zone countries within discontinued and established a fixed rate for each other change over to the euro with a three-year transition paper money and quit it

from the old system was excepted until 2002 at which point enough EURO notes and coins had been produced after its launch.

The euro was better than expected in open trading on its first day of usage. US dealers were amazed by how quickly replaced. The national currency for example, the mighty Deutsche Mark was predicted to trade in parallel but disappeared immediately following the interest.

Deutsche mark was predicted trading in parallel but disappeared immediately following the introduction of this currency. The euro zone expanded and changed significantly. Greece qualified for membership in 2001 and one nations joined in the years that followed as the world experience the financial crisis in 2007-2008. So did the eurozone had problems in Europe and still stand from the strict guidelines.

Member countries were expected to hear to and from the overoptimistic idea that the work ethics and viewpoints aren't dead of these countries would converge overtime. Aside from strengthening ties between euro zone, The euro helped increase tourism in that area and time will tell if this currency reform is the lasting solution

The many achievements EURO have largely disproved the predictions of the early critics.

First, EURO has created a zone of macroeconomic stability in Europe, with price stability and low-cost borrowing. The euro has put an end to costly changes in intra-European exchange rates that were often triggered by currency problems outside Europe. The inflation performance of the euro area offers clear evidence of the effectiveness of its institutional setup in achieving macroeconomic stability. Average inflation in the first 10 years of the euro area was on a par with the price stability benchmark of the European Central Bank of close to but below 2% annual inflation.

Together with the marked improvement in inflation performance over that of previous decades, there has been a sharp decline in price volatility. Standard-deviation measurements of inflation volatility show that the period since the launch of the euro has been more stable than any other postwar period of comparable length. Perhaps more importantly, the EURO has achieved well-anchored inflation expectations and high credibility in a relatively short time. This performance is remarkable given that 10 years ago the European Central Bank was still a new institution without a track record. Overall stability is further reflected in lower and less volatile long-term interest rates. Thus, the monetary union has solidified a Europe-wide culture of stability, with a decisive contribution from the single currency.

Fiscal policies have supported macroeconomic stability. Progress in fiscal consolidation has been significant, with fiscal deficits falling to only 0.6% of gross domestic product (GDP) in 2007 compared with an average of 4% in the 1980s and 1990s.

It has not been all plain sailing, however. Deficits increased at the start of the 2000s, calling into question the efficiency of coordination. Reform under the Stability and Growth Pact in 2005, building on the experiences of the first years of introduction, has improved the coordination of fiscal policies.

During in its first decade of introduction, it has been the spectacular creation of 16 million jobs in the euro area. Jobs have grown faster than in other mature economies, including the United States.

The majority of these improvements reflect reforms of labor markets and social security systems carried out in some member states under the Lisbon Strategy and the coordination and framework of EMU while on the other hand on microeconomic level, the euro has fortified the European Single Market and improved consumer welfare.

It has promoted the convergence of the money and capital markets through increased competition, market liquidity and transparency, and economies of scale and scope. The euro can be credited, together with growing liberalization and technological innovation, with the improved possibilities for risk diversification and more efficient allocation of capital resources. The most immediate and extensive impact of EMU on financial integration has been felt in the euro-area markets for unsecured money and derivatives. Almost as soon as the euro was launched, interest rates on interbank deposits and derivative contracts across the euro area converged fully on the benchmark. The elimination of exchange rate risk within the euro area has increased price transparency, reduced transaction costs, and heightened competition, thereby promoting trade within the Euro area.

Export price volatility has dropped, and greater price transparency has discouraged price discrimination between national markets. While the euro effect is difficult to separate from the impact of other pro-integration policies, even the most conservative estimates find a positive and exclusive euro effect on trade.

The euro has benefited foreign direct investment within the euro area and elsewhere also present evidence of the positive effects of EU and euro-area membership on FDI. They find that the adoption of the euro has promoted FDI from outside the euro area, but this effect has been only about half as strong as the impact within the area. Moreover, the euro has fostered domestic and cross-border mergers and acquisitions among both large and small firms, but the effect on small firms has been biased toward cross-border activity. The euro has had a very strong impact on mergers and acquisitions within the same sector in manufacturing.

This is what happened starting the crisis,

This new currency was centrally managed that is, there was a single issuer of this new currency. Which of course makes sense: In the United States, you don’t have 50 states issuing different currencies you just have the Federal Reserve, issuing dollars for the entire country.

Same with Europe: EUROZONE the zone of countries that had the euro as their currency. This new currency was managed by the European Central Bank, the ECB from in Frankfurt, Germany. The ECB’s primary concern, like all central banks was making sure that the currency it was supervising did not lose value. That is, it made sure that inflation stayed below 2% per year.

However, just like in the U.S., though there was a central bank in this case the ECB, each of the member states of this European Money, could issue its own debt.

So far, so good, The euro was printed and managed by the ECB in Frankfurt. The individual countries, Spain, France, Germany, Holland could each issue their own debt, and of course manage their own government budgets.

Now, the strongest economy in Europe is Germany’s. For our purposes, the reasons why of this don’t matter. What matters is, Germany’s cost of borrowing was the lowest of the eurozone.

This makes sense: If I make a million bucks a year, and borrow $10,000 for expenses and stuff, I’m going to get a pretty good interest rate from my credit card company or my bank. You know how lenders are: They lend you an umbrella when it’s sunny, then take it away when it rains. Since I don’t need to borrow the ten grand, all the lenders will trip over themselves to lend me money at extremely low rates, because they know I’m good for it. I won’t default on the debt.

Same with nations and same with Germany: German debt was always cheap, in the 1%–3% range, because Germany was good for it. After all, it’s the fifth largest economy in the world, and the biggest within the eurozone, racking trade- and fiscal budget surpluses year after year. So who wouldn’t feel comfortable lending money to the Germans? Nobody ‘cause see the Germans? They pay up debts all the time.

But here comes the problem: Banks felt very comfortable lending money cheaply to Germany. Germany was a member of the Eurozone. Therefore, lenders assumed that the other countries in the Eurozone were going to be as good a credit risk as Germany.

So the banks lent money to the other, weaker countries in the Eurozone at the same rates of interest as they lent to Germany.

Imagine you have a great credit rating so the bank gives your relatives a $100,000 a same consumer line of credit, just because he happens to live in the same house as you do. The

bank lends your relative the money because it says there’s a “given promise” that if your relative doesn’t pay back the money, then you will pay back for it.

Crazy, right? Right, but that is the core problem: Countries like Portugal, Italy, Ireland, Greece and Spain, countries whose initials spell out the acronym “PIIGS” could go into debt at the same rates of interest as Germany, just because they shared the euro as a currency.

The economies of the PIIGS were not as sound or as wealthy like Germany, but the lenders treated them fairly as if they were. Not only that, the lenders assumed that, if any country got into trouble, instant example, if any one of the PIIGS couldn’t pay back their loans the Eurozone as a whole would be good for the debt or would be responsible for the debt as well

This was great for the PIIGS. Because it meant cheap and plentiful loans, with which they could go out and buy stuff.

So that’s what they did: The PIIGS went into debt, actually too much of debt, as I said earlier it was sky rocketing, while the banks gave them all the slack they needed. Which makes complete sense: If before 1999, these countries were borrowing at say for example 6% or more, and all of a sudden their cost of borrowing drops in half, what will they do? They will go into debt.

Which is what they did again which results to massively earned debts.And what did these countries do with the debt? These countries created a false sense of prosperity.

This in a nutshell or in summary showed what happened between 1999 and 2010, when the Greek crisis first erupted: During those “boom” years (which were really no more than junior going crazy with the credit card), the various countries of the Eurozone went into massive debt, in order to both fund a social safety net, and cut taxes on their citizens.

In other words, something for nothing, bought and paid for with cheap debt. Kind of like the United States of America, but that’s for another time.

Though they now don’t want to admit it, the Germans encouraged this over-indebtedness, by the way as did to the French. Why? Because with this false sense of prosperity, the over-indebted nations bought German and French goods and services. German and French banks were at the forefront of lending money to the PIIGS—which essentially

made the whole scheme nothing more than vendor financing on a massive scale: its like “I lend you money so that you can buy my products”.

Just like a credit card company giving you teaser really low rates, the Germans and the French because of their banks and government institutions, gave the weaker economies all the incentive in the world to go into massive debt, and then go out and buy German and French products.

It was bound to end in tears. As is happening now. It all goes to the issue that all these countries are over-indebted. And that over indebtedness is being reflected in the sovereign bond markets.

What Are Bonds? What Are Yields? And Why Do They Matter?

A bond is a bit of paper that is traded, just like stocks. But unlike a stock, which is a piece of ownership in a company, a bond is essentially a promissory note: You lend me money, and I give you this piece of paper where I promise to pay you back. The bond has a face value, and an interest rate. The person who buys the bond at the market price collects the interest, and receives the principal of the bond on maturation. A person can own a bond, or sell it to someone else, just like a stock.

Corporations issue bonds, in order to finance factories, and its expansion. And governments issue bonds, in order to finance various infrastructure projects, as well as their deficit spending.

With all bonds, there are three pieces you have to understand: There is the face-value of the bond, there is the interest that the bond pays, and then there’s the effective return-on-investment of the bond, which is known as the yield.

The yield of a bond is what everyone pays attention to. The yield on a bond is a percentage value: It is the interest rate of the bond, times the face value of the bond, divided by the current price of the bond. The yield is inversely affected by the price of the bond: The higher the price of the bond, the lower the yield, and vice versa.

I will make a simple example for this essay, so if you see, it’s a seesaw: When the yield of the bond is going up, then the price of the bond is going down. When the yield is going down, then the price of the bond is going up and vice versa

Let’s see an example: Say I sell you a bond for €1,000, paying 5% interest per year. The bond is trading in the open markets at €900. So 5% times €1,000, divided by €900, equals

5.55% which makes the yield more widened, as they say in the business. That is, the yield has gone up, since the price of the bond has gone down.

But say instead that the bond has risen in value, which of course can happen: Say the price is up to €1,100 per bond. So 5% (the original interest) time €1,000 (the face value), divided by €1,100 (the current price, gives us a yield of 4.54%. The bond’s yield is said to be narrowing.

Since bonds all have different conditions insofar as maturation, interest rate, etc., it is simpler and quicker to speak of changes in yield only: “The yield is rising” means that the price of the bond is going down.

Why is the price of a bond going down? Because investors think that the person who owes the debt the bond issuer, is not necessarily good for the debt. That is, they think the debtor might default. So the owners of the bond sell it at a lower price, because they don’t want to have the risk of a default.

Why does a bond go up in price? Because the debtor might show signs that it won’t default—so the high yield makes it attractive for a buyer to pay more for the bond, thereby driving up the price, thus lowering the yield of the bond.

So what does this mean for these countries?

Well, when the yield of a government bond rises, it means that people are selling that country’s bonds. Take the above example of €1,000 bonds paying 5%. If the bonds are now at €900, the yield is at 5.55%, as per the above example.

Now, if the yield on that bond rises to 7%, what does that mean? It means that the bond is trading at distressed levels. Because for a €1,000 bond paying 5% interest to be yielding 7%, then the bond is trading in the €715 range. (The face-value price of €1,000 times 5% divided by a current price of €715 yields 7%.)

By the way, this is a simplified version of calculating yields. In markets, often as not, the “yield” being referenced is the Yield to Maturity which is a more complicated calculation. check out this discussion of my essay which explains it in relatively straightforward detail.

So say you’re a government, and you have to fund €1 billion for a bridge. You will issue bonds to finance the bridge, bonds that will pay an interest of 5% a year. In order to raise those billion euros, you have to sell not a million €1,000 bonds you have to sell 1,400,000 bonds with a face value of €1,000.

And therefore, you have to pay interest on 1,400,000 bonds, instead of 1,000,000 bonds. And when these bonds mature—that is, when they have to be paid off in full—the government won’t be paying out €1 billion in principal: They’ll be paying out €1.4 billion in principal, on what was supposed to be a €1 billion bridge. Because bonds are paid full face value on maturation.

So as government’s cost of borrowing has risen. And it’s all expressed in the yield.

That’s why yields matter. And unfortunately, rising yields is what’s been going on with European debt: They have risen massively because investors think there is a less likelihood that the bonds will be paid back in full.

Why does this matter? Because these nations are all relying on deficit spending: They spend more money than they bring in. So they need to issue more debt, in order to pay off their obligations, such as salaries, pensions, medical care, not to mention pay off the interest on the previous bonds they’ve already issued.

So in this situation, a country can get to the point where its bonds are selling at such a discounted value that it cannot issue enough bonds to simultaneously pay off their obligations and allow them to continue to function at their current level.

That is, countries can get to the point of bankruptcy depending on how high the yields on their bonds rise.

Now, About Greece

This is what happened to Greece, Its cost of borrowing rose so much that they no longer had the ability to raise the cash to pay off all their obligations.

So starting in April of 2010, Troika, the International Monetary Fund, the European Central Bank and the European Commission the executive arm of the European Union structured a bailout package, which was eventually passed through. The bailout package of course had some conditions, which the Greeks agreed to in order to get the money and which they then promptly failed to live up to.

the Greek Drama is in two parts:

One, Greece is a small economy within the EMU—about 2% of the Eurozone’s GDP, so therefore its debts, while massive, were all-in-all manageable.

Two, the bailout of Greece was supposed to be swift and decisive, and act as a signal to

the markets that the Troika would defend the Eurozone, and not allow any of its members to go bankrupt. In other words, Greece was a firewall or a protective wall, to protect the other economies.

But the problem was, the Troika said statedWhy? Because it became immediately clear that the only way to fix the Greek situation was by debt haircuts and haircuts were impossible, because they would bankrupt the European banks will also affect the American Banks too.Let me explain.

The Fear of a Credit Event

Part of any debt restructuring, be it a poor man’s bankruptcy, or the bankruptcy of a large corporation, is debt haircuts. That is, lenders get less than the 100% of the debt that they are owed.

For Example I borrowed $10,000 to a car dealership for a new car I bought last year, and I go bankrupt. The dealer will get a percentage of the money I have left after everything (including the car) is liquidated. But they won’t get the full $10,000 that I owe them, obviously, because I’m bankrupt: I owe more than I have.

Same with EU nations like Greece owed more than they had, so Greece’s lenders were going to have to take a haircut. That is, they would have to take less money than they were owed. This is what’s known as a “credit event”. This was a problem. If there was a haircut on Greek debt—a credit event—then the banks and insurance companies which held the debt (predominantly German and French banks) would have to write a loss on those loans. Huge losses. Losses bigger than their capital.

Thus these banks would go bankrupt, if there was a credit event in Greek debt.

Even if they didn’t go bankrupt, these financial institutions would have to sell off other bonds, in order to raise the cash to stave off bankruptcy.

This massive sell-off of sovereign bonds would have a contagion effect: In order to cover their Greek bond losses, banks would have to sell their Italian, Spanish and French bonds at a loss so as to raise the cash to stay solvent, which would in turn make Italian, Spanish and French debt toxic. In other words, it will cause domino effect and would felt by others too

Furthermore, American banks, which don’t own much in the way of PIIGS debt directly have written a lot of insurance on those sovereign bond, The famed credit default swaps

“CDS”. Bank of America especially has made a lot of money selling CDS’s on those debts in 2008, 2009 and 2010, as has JPMorgan. If those sovereign bonds defaulted, those American banks would have to pay off these CDS’s and also they would go bankrupt too

Everything is connected, A credit event in Greek bonds would cause credit events in Italian, Spanish and eventually French bonds too, which would bankrupt European banks as well as American banks basically, a repeat of the 2008 Global Financial Crisis, only bigger, and without the happy ending. This is why the Troika said. They talked tough, and they even put the gun to Greece’s head,Pass these measures, or else no bailout money. But they never pulled the trigger and let Greece fail, because if they did, the European and American banking sector would collapse.

Since the Greek financial hole grew bigger between 2010 and 2011, because the Greek’s didn’t live up to most of their promises a second bailout package had to be created.

Again, this time, it was because the Germans in particular feel that they are spendthrift countries and nobody likes to feel like the chump who’s paying for other people’s good times.

There is enormous political pressure on Merkel to not save Greece. The people pressuring Merkel don’t realize what will happen if Greece collapses. So before the Troika plus German Chancellor Angela Merkel and French President Nicolas Sarkozy finally came up with a solution to the Greek problem. I say solution in the safest possible sense of word, the Europeans had been going around the world, hand in hand, asking emerging markets especially China to fund their bailout facility. They had been politely refused because they’re not stupid. They saw that the bailout facility, the European Financial Stability Facility (EFSF), was just a lot of smoke and mirrors, essentially throwing good money after bad.

Through some clever accounting tricks and some not-so-clever accounting lies involving accounting standards, the Europeans managed together a workable EFSF which could give Greece and potentially one of the other PIIGS a lifeline.

But in order to show that they were serious, the Troika and Merkel and Sarkozy insisted that the Greeks agree to a serious of painful austerity measures. The big news, however, was that this second bailout of Greece included haircuts on Greek debt. The advertised number on the Greek haircuts was fifty percent. Though when you looked more closely at the details, it was more like 20%. The deal stipulated that the haircuts on the Greek debt would be voluntary as opposed to be forced, which would have triggered a credit event. But then after that, Georgios Papandreou, the Prime Minister of Greece, threw a monkey wrench into the Rube Goldberg which is the Second Greek Bailout Package

The Eurocrats famously do not like going to the public to ask for their support, they like

to dictate instead. Why? Because they consistently lose the popular vote, to the point where they no longer bother putting things up for a vote. For Papandreou to put the austerity package to a popular referendum meant that it would likely not pass, because no citizenry likes to be asked if they want their government to give them less services and entitlements. Therefore, the Troika suspended the €8 billion tranche of the first bailout package that the Greeks were supposed to get in November. Without that, Greece will goes bankrupt.

So Papandreou said that there would be no referendum But the damage was done, The bond markets got so freaked out that they started looking at the next weak link in the European chain.

So Now, We Have Italy

Italian debt was yielding about 3.5%, very respectable. Italy, furthermore, has a very large debt, but it is far from insolvent: In fact its government regularly meets its budget with a bit of a surplus. Balance of trade is okay, growth is low but in line with the rest of Europe. the Berlusconi government is fairly competent and efficient.

Overall, Italy is in pretty good shape.

But it needs more debt to pay off previous debts, and to shore up its economy, which is in a recession much like the rest of the world. Italy’s debt load is growing, but strictly because its government is spending to prop up the Italian economy. Nevertheless, after the Greek fiasco, the bond markets turned on Italy. Italian yields rose from their 5% level then spiked on to above 7.6%, which is potentially dangerous. Why dangerous? Because at those levels, no advanced economy can finance itself and not to mention the fact that certain derivatives require that yields stay below. If they remain above certain yield numbers for a set period of time, they are considered credit events, which triggers CDS’s, which lead to bank bankruptcies. So those yields have to go down now, fast.

This crisis in Italy has led Silvio Berlusconi to announce he will resign, once austerity measures are passed. His resignation will likely calm the markets, for a bit. What strikes me is about the Eurocrats’ response. They come up with new and tricky packages, and a lot of flowery promises. But the Europeans don’t seem to understand that they have a nuclear weapon at their disposal—which they refuse to use.

The easiest way to fix this entire debt situation would be for the European Central Bank to simply print up money, and go out and buy enough Greek and Italian debt to bring down their yields.

It wouldn’t even have to be very much, a mere €50 billion would do the trick. The fear that the markets would have of being caught on the wrong side of a trade against the ECB would be enough to keep the markets docile and quiet.

I’m not saying this is a best solution to the current situation or even a solution at all. However, you cannot make sound economic policy, as you react to a crisis. For example you have to stabilize the patient first, before you give him the treatment not operate him for liver cancer while he’s still bleeding from a gunshot wound to the leg.

Having the ECB come in and make them calm the markets like the Swiss National Bank did would be the best way to get the European house in order, and then implement the structural reforms and austerity measures that everyone agrees need to be implemented. But the ECB isn’t stabilizing the patient. Why? Because the Germans are greedy that’s base on what I think.

See, if the ECB does the easing, the Germans are afraid that their currency will weaken or devalued,which they do not want, because they are a creditor nation. If the Euro’s value erodes, then Germany will have lost some purchasing power so that’s why they are afraid for that

They are so afraid of the Euro weakening I guess, and thus the Germans losing a bit of their surplus that they are making the other economies in the Eurozone crash.

The Germans do not seem to understand that, if the nations of Europe go down, there will be no buyers for their goods and services so they will suffer too.

Thus the ECB sits there, while this Greek problem becomes now an Italian problem and soon a French problem. The yields of French bonds are rising precipitously, and already one French bank, Credit creation , is in trouble over the Greek dilemma. It’s only a matter of time before the big French banks start tumbling and have a problem. and then France too, unless the bond markets are calmed and become stable.

So What’s Going To Happen?

What’s going to happen is, best case is if the Germans come to their senses and try to be more generous, and the ECB starts buying up European sovereign debt, calming the markets. Greece and a couple of other small or weak Eurozone countries exit the European Monetary Union, go back to local currencies, devalue, and then rebuild their economies; say Greece, Portugal, Spain and maybe Italy. And finally measures are imposed, fiscal budgets are put on a sounder footing, and things will be good themselves in a few years to come, if this would only happen I guess.

Worst case? Italy gets really sick, and then France falls as well, leading to the eventual break-up of the whole Eurozone, with Germany, Austria, Holland, Finland and Belgium maintaining the euro as their currency.

This would not be a good thing for those countries, by the way: If the union between France and Germany breaks, the non Eurozone countries would be poor, so they would

not be able to buy the goods and services of the remaining Eurozone countries. So all the countries would lose, if there is a break up of the monetary union.

Conclusion (to sum up)

When the euro was launched, critics worried that it was inherently unstable because it was institutionally incomplete. A monetary union, they argued, could not work outside a fiscal union. Proponents of the euro, by contrast, believed that a currency union could survive without a fiscal union provided it was held together by rules to which its member states said. If, however, a rules-based system proved insufficient to keep the monetary union together.

Many supporters assumed that the resulting crisis would compel politicians to take steps towards greater fiscal union, proponents of the euro seemed to have been vindicated. The euro enjoyed a remarkably uneventful birth, and a superficially blissful.

But its adolescence has been more troubled, lending increasing weight to the euro’s critics. If anything, a shared currency outside a fiscal union has turned out to be even less stable than the critics imagined.

Common fiscal rules did not guarantee the stability of the system, not just as North European politicians like to claim because they were broken, but also because they were inadequate.

The Eurozone now faces an existential crisis – and EU politicians their moment at root, the Eurozone’s sovereign debt crisis is a crisis of politics and democracy. It is clear that the Eurozone will remain an unstable, crisis-prone arrangement unless critical steps are taken to place it on a more sustainable footing.

But it is equally clear that European politicians have no democratic mandate in the short term to t ake t he s t eps r equ i r ed . The r ea son i s t ha t g r ea t e r fi sca l i n t eg ra t i on wou ld t u rn t he Eu rozone i n to t he ve ry t h ing t ha t politicians said it would never be: a ‘transfer union’, with joint debt issuance and greater control from the center over tax and spending policy in the member-states. Eurozone leaders now face a choice between two unpalatable alternatives.

Either they accept that the euro zone is institutionally flawed and do what is necessary to turn it into a more stable arrangement. This will require some of them to go beyond what their voters seem prepared to allow, and to accept that a certain amount of rule-breaking is necessary in the short term if the Eurozone is to survive intact.

Or they can stick to the fiction that confidence can be restored by the adoption (and enforcement) of tougher rules. This option will condemn the Eurozone to self-defeating policies that hasten defaults, contagion and eventual break-up. If the Eurozone is to avoid the second of these scenarios, a certain number of things need to

happen. In the short term, the ECB must insulate Italy and Spain from contagion by announcing that it will intervene to buy as much of their debt as necessary. In the longer term, however, the future of the euro hinges on the participating economies agreeing at least four things. mutualising the issuance of their debt, adopting a pan-European bank deposit insurance scheme, pursuing macroeconomic policies that encourage growth, rather t han s t i f l e .