Stephen King: To heal the Sicks – and to punish them – they must be broken up

Economic Outlook: Perhaps it is time to bring back the Kingdom of Piedmont-Sardinia and the Papal States

Large nation states sometimes behave in ways that lead to excessive systemic risk. Like some banks – known as systemically important financial institutions (SIFIs) – some countries perhaps are both too big to fail and too big to save.

Italy, to take one example, is a "systemically important country or kingdom" (Sick for short). Sicks have the capacity to inflict damage on themselves, on each other and on a whole host of innocent bystanders. By doing so, they threaten massive economic hardship, the costs of which will ultimately fall on hard-working taxpayers, often in other far-flung parts of the world.

Sicks need to be reformed to ensure that the world economy will never again be held hostage by the consequences of their own short-sighted and misguided behaviour.

The first step, ideally, is to break the Sicks up so that they no longer present a major systemic threat. Italy should be split asunder. The political arrangements that existed before unification in the 19th Century offer a useful template. Perhaps it's time to bring back the Kingdom of Piedmont-Sardinia, the Papal States and the Kingdom of the Two Sicilies.

This reform is designed not only to punish Italy for its fiscal sins but also to prevent future Sick misdemeanours, and other countries would also have to be broken up: no Sick would be immune. The UK would be split into its home nations. Bavaria and the Duchy of Baden would become independent states and Germany, as nation, would cease to exist. The US, the biggest Sick of all, would be separated along early 19th Century lines. The Eastern seaboard, the southern states and California would all become newly independent entities (and, in California's case, a newly bust entity).

The second step is to recognise that the Sicks' funding models are hopelessly outdated and only likely to cause persistent financial disruption. Selling pieces of paper in return for a vague promise of repayment at some distant future date is clearly no way to deliver financial stability. The eurozone crisis surely demonstrates that governments cannot be trusted with this mode of wholesale funding, particularly when it imposes unacceptable hardship on future taxpayers. Should Sicks wish to live beyond their immediate means, they will have to find other ways of funding their lavish lifestyles.

A simple principle would be to insist that countries fund their balance of payments deficits not through the hot money associated with portfolio investment but instead via an increasing reliance on foreign direct investment.

Foreign creditors should be able to get their hands on real assets – alongside the associated income stream – and not just pieces of paper. Italy, for example, might be able to sell the Colloseum and Pantheon to the Germans, who might better manage the tourist potential of these two Roman relics. The UK could sell Stonehenge to the highest bidder. The Americans might wish to sell California to the Chinese. The Everglades, meanwhile, could be turned into a greenfields site for Latin American investors keen to expand their property portfolios in Florida. These long-term investments would do a great deal to deliver lasting financial stability, marking a welcome break with the upheavals of the recent past.

Meanwhile, there is increasing evidence that, within the assorted Sicks, there has been a big increase in so-called casino capitalism. The third step, then, is to separate the casinos from less risky and socially more useful economic activity. Fortunately, the casinos are conveniently located geographically. It would thus make sense to turn New York, London and Frankfurt into independent city states no longer able to hold the world's taxpayers to ransom. Hong Kong provides an admirable working example: a financial version of the Vatican City.

The fourth and final step is to insist on a review of the incentive structures which have led to such huge distortions in financial markets. Elected politicians in the Sicks offer only short-term solutions, and are hostage to the electoral timetable. Voters are myopic, too often unwilling to think about the interests of future generations or, as Angela Merkel, the German Chancellor, implied recently, the interests of those beyond their nation's frontiers.

Better, then, to replace the elected politicians of Sicks with technocrats able to take the "long view" – an approach already adopted in Italy and Greece – and better, also, to deny voters referenda on issues that may have undesirable international consequences. Democracy clearly leads to undesirable short-termism, focusing on the narrow self-interest of the current crop of voters at the expense of a country's foreign creditors and its future generations.

To buttress these reforms, we need an effective international body able to impose the discipline which, until now, has been lacking. That means a beefed-up IMF with much deeper pockets and powers to ensure that financially irresponsible Sicks can no longer hold the rest of the world to ransom. Sicks finding themselves in trouble would be bailed out by the IMF but would be subject to tough conditions set by the IMF's newly empowered main creditors: China, Russia and Saudi Arabia. Only then will the Sicks be healed.

Or perhaps not. My flights of fancy nevertheless reveal an important point. There is a clash between the democratic interests of individual nations and the shared responsibilities of countries to one another which stems from the enormous increase in cross-border financial claims built up over the past 30 years.

The key lesson from the current crisis is not that some countries are too big to fail and, simultaneously, too big to save. It is, instead, that investing in any kind of asset is an inherently uncertain business, particularly when the investment is in foreign climes.

Those countries which demand the safe return of their investments are, in effect, insisting that all the risks are absorbed by those nations that borrow. That is politically and ethically an unacceptable position and, as we're beginning to see in the eurozone, ultimately self-defeating.

The sickness lies as much with the selfish demands of the creditors as it does with the misbehaviour of the debtors. The creditors need to understand better the risks they're facing when they lend abroad. In hindsight, for example, it seems extraordinary that Germans preferred to invest in Greek government paper than in Germany's own domestic industry. They did so because they felt sure they'd get their money back. Both history and current developments suggest that view was ultimately naive. Borrowers may have borrowed too much but they only did so because lenders were overly generous in the first place.

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