Time to tell the taxpayer tough truths: why and how to save the euro

By Luis Arroyo, in Madrid | ‘It’s time for plain-speaking to Europe’s electorates‘ by Howard Davies* is, perhaps, the most accurate article I have read about The Problem. It explains very convincingly why and how the euro has to be saved.

1) Why: re-denomination of the euro contracts would be just legally impossible, causing fatal effects. This is the most powerful reason, almost the only one, to defend the euro firmly:  no one knows today which euro-denominated contracts, and they are to be found all over the world, should be re-denominated into one or more new currencies. Would it be on the basis of nationality, or residence, or intended place of settlement of the contract, or law of jurisdiction over the contract? Who would decide? Which courts could enforce whatever was decided? In every case of re-denomination there would be a winner and a loser, so every attempt to enforce a change would be disputed. The,n arrangements for the new currency(ies) would be needed. Intricate preparations were made over many years to introduce the euro –we were involved.

2) How: there is no time for trying other ways, it’s the European Central Bank. What leaders must explain is that, firstly, over the medium term there is no alternative to some form of federal fiscal arrangements. Secondly, that in the period before longer term fiscal transfer arrangements can be put in place, some euro area governments will need debt relief. And lastly, that the ECB will need support from governments and their taxpayers to provide indefinite liquidity to maintain the machinery of day-to-day economic activity. This need not affect its operational independence.

The ECB’s balance sheet will be extended and is likely to need support –which can ultimately come only from governments. Central banks are almost always ultimately backed by taxpayers. This need not affect their operational independence. Leaders must assure their electorates that explicit fiscal support for the ECB by eurozone governments, if it were needed, would only put the ECB in the same position as other central banks whose operational independence is unquestioned. In the rest of the world, central banks support markets by buying government debt with the taxpayer, through governments, as ultimate guarantor of their soundness.

Until the euro zone’s leaders have explained to their electorates these four unavoidable facts, we will all be going up blind alleys when time is of the essence in averting potential economic and social disaster.

* The writer is a former chairman of the UK’s Financial Services Authority. David Green, a former head of international policy at the FSA, is co-author. Their book, “Banking on the Future: The Fall and Rise of Central Banking”, is published by Princeton University Press”.

Luis Arroyo is a former Bank of Spain economist. He writes for www.consensodelmercado.com.