If countries at the very center of the global economy shift to new currencies in a panic and at a time of global recession and large-scale defaults, the complex web of transactions underpinning international trade and finance will be stretched to the breaking point. European governments’ access to bond markets is already impaired and may disappear altogether if investors are uncertain about the currency denomination of their claims. Banks will cut trade finance if they are in danger of being repaid in highly depreciated national currencies, while importers may be unwilling to borrow in dollars if the local-currency cost will soon be prohibitive. Swaps and futures markets will not function if investors are uncertain about the value of repayment. Stress tests to see how currency systems would work in the event of a euro breakup show unequivocally that a very long time and large resources would be required to get the global systems functioning smoothly again. U.S. regulators are already urging banks to reduce their European exposure and identifying vulnerable financial institutions, but this merely adds to the pressure on European governments.
Instead of traveling all the way to Europe, Secretary Geithner should take a car ride down Pennsylvania Avenue and tell a recalcitrant Congress the bad news. Europeans cannot handle this crisis on their own. Germany, the only country in the euro zone that is remotely safe from a market panic, can help Greece, but it cannot rescue Italy and Spain. German debt is already 80 percent of GDP, and Italian debt alone exceeds it. The euro zone is a monetary union, not a political union, and not a country. Even if it were, would you expect New York to bail out California? Blanket European Central Bank guarantees to purchase Italian and Spanish debts would not solve the underlying problems: would you see a Fed guarantee as the solution to the problems of Michigan?
The only sensible short-term solution is an adjustment program carrying tough conditionality, sponsored by IMF and the European Financial Stability Facility. To cover Spain and Italy’s financing needs over the next three years, the likely timeframe an adjustment will require, requires an additional $2 trillion. That’s the size of the “bazooka.” Half of this should come from the euro zone and the other half from the IMF. The IMF has about $400 billion available, but it needs it to support the rest of the world if the crisis worsens, so the $1 trillion is the net addition it needs. The U.S. share of this is about $160 billion if the euro zone can cover its share of expanded IMF resources in full—but may be higher, perhaps $250 billion, if it cannot. The rest will come from China, Japan, the UK and a host of advanced and emerging markets. If we take the lead, we can make it happen—in fact, we are the only ones that have the heft to do so.
This adjustment program is a loan that may never be disbursed, not a gift. It is not an outlay but a contingency. If it is disbursed, we are very likely to get our money back based on a long track record of IMF lending, which is senior to all other debt. The borrowing countries will be subject to heavy conditions, but we will also insist that conditions be imposed on the European monetary union as a whole: they must ensure that the program is sound, receiving proper support and moving ahead with reforms to make the union sustainable in the long term and prevent a similar episode in the future.
If the United States does not act, all bets are off. We may well have a Lehman repeat, or perhaps worse: the bad debts are much bigger, and so much fiscal and monetary ammunition has been spent already. Europeans will long remember that we stood aside in their time of need. Moreover, if China, Brazil and Mexico end up helping (they seem amenable provided Europe gets its own act together) but we are missing in action, the blow to our prestige will be immense. Europe and the whole world will see it as irrefutable evidence that America’s days as global leader are numbered.
In other words, the message to Congress is that the question is not whether the United States will pay for the Euro crisis (it will) but how.
Uri Dadush and William Shaw are scholars at the Carnegie Endowment for International Peace. They are the authors of Juggernaut: How Emerging Markets are Reshaping Globalization (Carnegie Endowment, 2011).