This time it looks like it is serious. The recent sharp rise in borrowing costs for all Eurozone countries, even Germany, has finally exposed just how bad the situation has become. Rising borrowing costs and austerity induced recession is pushing the Euro to breaking point. There is simply no way that Italy and Spain in particular can survive with these high interest rates. Sooner, rather than later, both of these countries will need to apply for life support from the EU and the IMF or face immediate default.
Alas for both Spain and Italy there is no more money in the kitty. Neither the EU nor the IMF has the kind of money needed to support either Spain or Italy, never mind both at the same time. At this time of crisis, urgent measures are needed, and fast. Unfortunately the EU is pretty much institutionally incapable of acting urgently. The solutions not just for Italy and Spain, but for the whole Eurozone, are by now very clear. They just need our leaders to recognize the inevitable and act accordingly. This however will be very difficult as both Angela Merkel and Nicolas Sarkozy have been so outspoken in opposition to almost all the necessary changes. They will have to be prepared to eat rather large doses of humble pie very quickly if the Eurozone is to have any chance of survival.
The outline of the solution comprises three inter-related parts, which need to be put in place pretty much simultaneously. The first and most urgent of all is to give some relief to Spain and Italy. This can only be done in the short term by the European Central Bank (ECB). All the ECB has to do is to act like all other central banks and be the lender of last resort for Eurozone governments in difficulties. The ECB simply announces that it will buy all Spanish and Italian government bonds at a lowish interest rate, say 3.5% To do so it will print as many Euros as it takes. This would immediately end the pressure on all Eurozone countries. If this was to continue for ever then this policy would lead to higher inflation. But in the current situation with low underlying inflation and recessions on the horizon, rising inflation is the least of our worries. This action can be taken very quickly and really only needs the agreement of Angela Merkel, who to date has adamantly refused to countenance such action by the ECB. Perhaps the threat of the collapse of the Euro will concentrate her mind wonderfully.
The second part of the equation relates to the need for some Eurozone countries, read Italy, Spain, Portugal, Ireland and Greece, to get their respective houses in order, so that they do not face such severe difficulties in the future. For not unreasonably, Germans and others are a bit reluctant to support countries in trouble unless they can be assured that they will take the necessary measures to get their public finances in order and to make their economies more competitive. What this crisis has brutally exposed is that though the Eurozone has a common currency it does not have a common state. It is most unlikely that the Eurozone countries will suddenly agree to set up a joint Federal state à la USA. However all the talk is of the need to create a Fiscal Union. This is where things begin to get a bit hazy. In the first place such a development will take a great deal of time. It will require a new treaty, which may or may not involve all 27 member states in the EU. In the case of Ireland any new treaty would probably have to be supported by the electorate in a referendum.
There is also the tricky matter of just would a Fiscal Union involve? At the moment it seems to mean that each country in the Eurozone will have to send its budget to Brussels to be scrutinized and approved or rejected by some new supranational Eurozone body. If rejected the member state would have to revise its budget in line with the changes proposed by this new body. It the member state refused it would be fined. Nice in theory, but can anyone see this really working? If Italy, say, refused to change its budget proposals on the grounds that it would cause too much suffering for poorer Italians, and also refused to pay any fine, would the rest of the Eurozone really force Italy out of the Euro? In which case it could probably do so now.
For a Fiscal Union to be credible - to the markets that is - then it almost certainly needs some kind of common Treasury, which would be responsible for most taxation and most government spending in all the Eurozone. Not a very realistic outcome at the moment, if ever. Something needs to be done though, if only to make it politically feasible for Angela Merkel to agree to the first proposal - allowing the ECB to buy up government bonds. She needs to be able to convince her fellow Germans that there will be no backsliding by other Eurozone countries. The paradox here is that while Germany has been historically quite open to this kind of increased federalism, it is France which has opposed such a loss of sovereignty. A bit of humble pie for M. Sarkozy to eat.
The final piece of the jigsaw is to get some renewed growth in the Eurozone, in particular in Spain, Italy, Portugal, Greece and Ireland. Quite how this can be done while the powers that be are still in thraw to the mantra that austerity and ever more austerity is the answer, is not at all clear. However if Germany does not agree to the above changes to the remit of the ECB, then all the rest becomes academic and very quickly too. Wolfgang Munchau has a very good piece in the FT in which he reckons the Eurozone has at most 10 days to avoid a rather messy and expensive collapse.