Leading article: Tackle the cause, not the symptoms

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The Independent Online

There has has been a depressing pattern to these European financial bailouts. Big numbers are announced and the markets are, for a while, reassured. Then investor doubts creeps back, doubt snowballs into panic, and, finally, more money needs to be promised. Is the latest package from European finance ministers going to break that pattern?

There are grounds for hope. This is the first serious attempt by European politicians to get ahead of the problem. For one thing, the scale of this package – €750bn – is sufficiently large to have exceeded investors' expectations. It is comprehensive too, including a commitment from the European Central Bank to buy up eurozone government and private debt. It represents a serious statement of intent from Europe's leaders that they will do what it takes to protect the eurozone's members and the single currency.

Yet there are also grounds for doubt over whether this latest package will mark a turning point. Assuming the package will buy time for most financially troubled eurozone countries to make their fiscal adjustments without being crucified by the bond markets, there remains the problem of Greece. Under the separate eurozone/International Monetary Fund plan for Greece, severe fiscal austerity will be required from Athens for three years. And, at the end of that period, Greece is still projected to be left with an unsustainable public debt burden of 150 per cent of GDP. This is why the markets, despite the loosening of the eurozone purse strings, fear that Greece is destined to default and, quite possibly, crash out of the single currency.

Policymakers thus find themselves in a Catch 22. If they were to engineer a restructuring of Greek debt, the investor panic would most likely spread to the sovereign debt of Portugal, Spain, Ireland and Italy. But if Europe does not let Greece restructure its borrowings, the markets are likely to continue to doubt Athens' ability to take the pain involved in bringing down its deficit.

There are two intertwined problems here: a European banking crisis and a European economic crisis. The banking crisis is that financial firms across the continent, including in Britain, are heavily exposed to dodgy southern European sovereign and private debt, which they recklessly snapped up in the first decade of the euro's existence. If that debt defaults, we could be in for a fresh banking crisis and a new credit crunch. The economic crisis is that peripheral European countries, after a decade of capital inflows and relative inflation, face a severe fiscal correction to reduce their yawning deficits. Normally, a currency depreciation would ease the pain of that correction. But Europe's stricken peripheral nations are locked into the eurozone. That currency straitjacket could make it politically impossible for governments to impose the sort of austerity measures needed to bring their public borrowing levels down. The single currency will also restrict their ability to grow their way out of their difficulties.

The latest rescue package is certainly the most convincing effort yet from European leaders to take control. But until policymakers start tackling the causes of Europe's twin crises, rather than merely the symptoms, this is likely to prove nothing more than a disaster postponed.

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