Michael Spence, professor of economics at New York University’s Stern School of Business thinks the risks in Europe needs socialization in the short-term. The Eurozone is going to stand or fall depending on the reforms they undertake in Spain or Italy.
Unfortunately, those reforms will take time to show the results. Borrowing costs however remain the dominant problem right now and to bring the sovereign yields of Spain and Italy down, the intervention of core European institutions and the IMF are required as the reforms are initiated. In order to do that, they would need to keep buying peripheral bonds, which involves socializing the risks involved.
The Federal Reserve’s latest move to extend the Operation Twist through the end of the current year had barely any impact on the markets; it was a non event which basically suggests that central banks are running out of monetary tools that can offer solutions.
The solutions to the current problems require a two-pronged approach, the short-term and the long-term, according to Dr. Spence. Both the Spanish government and Italy’s Mario Monti has to garner enough popular support for dramatic reforms that focus both on fiscal stability and economic growth, and the growth part is crucial. Then they would need to seek support from the core EU countries.
The second issue is the banking sector which has not been put together properly. Any large European bank has operations all across Europe and sometimes all over the world and they need to centralize the regulations and deposit insurance schemes. Eventually the Europeans have to agree to some form of centralized budgeting and fiscal structure and get over the current situation where they have a monetary union and but complete fiscal decentralization.
Asked about to comment on former Italian Prime Minister Silvio Berlusconi’s recent observation that leaving the single-currency union shouldn’t be considered blasphemous, Dr. Spence said Italy has not reached that point yet where they should think about quitting the common-currency zone. However, if borrowing costs continue to remain at 7-8 percent, there’s little incentive for Italy to continue in the currency union particularly when Rome’s debt-to-GDP ration has touched 120 percent. With such high debt levels, Italy will never come out of the “hole.”
In short, we need interim financing to bring yields down to manageable levels till private external investors are convinced that the system has turned around and return to the Spanish and Italian bond markets. You can watch the video here.
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