Editor’s note: As fears about the eurozone continue, this publication is interested in different viewpoints, including contrarian ones. An example below is from Citigroup chief economist Willem Buiter, who argues that the EU has more banking and government firepower to prevent default problems than some commentators and investors imagine. As usual, this publication does not necessarily concur with the views expressed, but lays them out as part of an ongoing debate.
A former interest rate setter for the Bank of England and now economist at Citigroup claims fears about the future of the eurozone are overblown and that the single European currency will emerge stronger from recent debt wrangles.
In a note entitled Europe: Fear and Panic Make Poor Counsellors, Willem Buiter writes: “Europe never does things neatly, it seldom gets ahead of the curve and often only does the right thing when all else has been tried and failed. But it has considerable skills at lurching from crisis to crisis. This sovereign and banking crisis is likely to result in a stronger EU and euro area.”
Buiter admits that he is taking a “contrarian” view in being optimistic about the ability of EU policymakers, including the European Central Bank, to fix the debt woes of countries such as Greece, Italy and Spain. These worries, added to debt wrangles in the US, have pummelled global equity and debt markets and propelled gold to record highs above $1,800, although the metal has retreated in recent days.
“The EU and the euro area have the means to prevent disorderly sovereign defaults even when the sovereigns are most likely insolvent (Greece, Ireland and Portugal) and, in the case of Greece, already engaged in a process that will lead to a selective sovereign default – probably within a month,” Buiter, chief economist at Citigroup, said. He was a member of the BoE’s Monetary Policy Committee from 1997 to 2000.
“The EU and the euro area also have the means to prevent fundamentally solvent sovereigns (including Spain and Italy) from being pushed into unwarranted defaults through a fear-driven denial of market access – when the fear of default bootstraps itself into an actual default, through soaring funding rates or complete loss of market access… Fears of a downgrade from AAA levels, something that, since the US downgrade, is causing problems especially for France, are a less important issue.
“They can and in all likelihood will be addressed by additional frontloaded fiscal austerity in France and Belgium,” he writes.
Buiter continued: “In recent days, the markets have seen turmoil and indeed flashes of panic about euro area banks, including some of the leading French banks. Hard information is scarce. We have seen no evidence that any French bank is insolvent or even seriously undercapitalised. It is certainly possible that the turmoil in the sovereign markets of the narrow periphery, and now also of the broad periphery, may have had capital adequacy consequences for some banks in France and elsewhere in the EU. But even the most pessimistic reading of the situation does not justify the panic and fear that we are seeing. Much of this response appears to reflect bad information and ignorance.”
Buiter argues that France retains its AAA rating on sovereign debt and can borrow from the markets and “recapitalise any bank that needs additional capital”.
“If the required capital injection were to be large, the French government would probably have to credibly commit itself to additional front-loaded fiscal austerity measures to convince the markets that it remains committed to fiscal sustainability and the defence of its triple-A rating. In our view, such a credible commitment would no doubt be forthcoming,” he writes.