Europe's Next Crisis May Be One Of Solvency

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Includes: ADRU, DBEU, DBEZ, DBIT, DEZU, EDOM, EEA, EPV, EUFL, EUFN, EUFS, EURL, EWI, EZU, FEEU, FEP, FEU, FEUZ, FEZ, FIEE, FIEU, GSEU, HEDJ, HEWI, HEZU, HFXE, IEUR, IEV, PTEU, RFEU, UPV, VGK
by: Desmond Lachman

A critical mistake that the International Monetary Fund made in its initial handling of the 2010 Greek sovereign debt crisis was its failure to recognise that Greece had a solvency rather than a liquidity problem. In championing the creation of a European Monetary Fund ("Europe must create its own 'big bazooka' monetary fund", December 8), Jean-Pierre Landau does not seem to entertain the idea that the next European sovereign debt crisis might again be one of solvency rather than liquidity. If that turns out to be the case, it will not be resolved by the provision of unlimited temporary liquidity alone.

Italy's current very difficult economic and financial situation suggests that it is not fanciful to think that the next European crisis could again be one of solvency. Not only does Italy have a public debt to gross domestic product ratio in excess of 130 per cent and a banking system with non-performing loans in excess of 15 per cent of its balance sheet. Italy has also distinguished itself since it adopted the euro in 1999 by its inability to generate meaningful economic growth.

The Italian case should also concentrate the mind as to how large the resources of the EMF would need to be to successfully rescue a country of Italy's size. Indeed, with public debt in excess of €2.5tn and a banking system with a balance sheet close to €4tn, the resources that the EMF might need to save Italy would be too large for the German government to countenance.