Tuesday, 7 January 2014


Jack Lew, the US Financial Secretary came to deliver a clear message to his EU peers.  It is gravely risky to proceed with a banking union without a backstop of sorts that can fill any capital deficiency hole resulting from a credible Asset Quality Review, bank stress test or call it what you like.

Jack Lew is speaking with the experienced gained on the other side of the Atlantic from the successful recovery  from the banking crisis of 2008.    The US threw capital at the banks in 2008/2009, sometimes against the banks' own wishes, to ensure they could be restored to health quickly and re-start servicing through proper credit channels the needs of the economy to grow out of the recession.

Having a federal system with one Treasury and a federal parliament/government, the US could use fiscal policy for providing the  capital funds needed to restore confidence in its banking system.

Europe can't do that as it has no federal set-up.   So it is struggling to restore its banks back to health. Without succeeding to restore banks' ability to perform their function of transmitting credit where the ECB monetary policy aims to deliver it, Europe's growth will continue to be sub-optimal and recovery will be painfully slow.

Those who ultimately matter in Europe, will politely invite Mr Lew to mind his own business.   Germany has decided that it does not want to risk its taxpayers' money by providing a creditable backstop for a banking union crisis.   The policy choices were made in 2013 and now the future can only unfold the consequences of such policy decisions.

The Germans hope that over a long time countries like Italy will gradually restructure and shape their economy in German tradition.   The risk is that the Italians, tired of austerity without growth, will protest by electing to government, probably in 2015, extreme parties which challenge the status quo and prefer bread and butter to fiscal orthodoxy and democratic principles.

Italy's importance to the Eurozone can hardly be overstated.  Italy still needs to fix its banking crisis to end its credit crunch.   It needs to cut business taxes on labour to gain competitiveness.   It has no fiscal space to finance such tax cuts so it would have to raise other taxes or cut social expenditures.  To reduce its debt level to within 70% of the GDP over the next 20 years it would have to run a primary surplus, i.e. a fiscal surplus before payment of interest , on a scale never seen in modern history.

Italy has not yet undertaken serious economic reform like Ireland, Spain and Greece, and is the source of gravest risk for the stability of the Eurozone.   Given the political fragility of all Italian governments it is more likely that the electorate will rebel against endless austerity rather than continue reforms on a length of scale which tire the healthy let alone the feeble.

As is common knowledge policy choices can be revised, but only when in severe crisis mode.  Italy has all the ingredients to bring about such crisis that Jack Lew has come to Europe to warn about.   But about that the Germans are stone deaf with double layered plugs in their ears.

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