It's amazing what you can do with a trillion dollars

The bailout of the euro exposes some deep flaws in the EU model

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The Gazette, Wednesday, May 12, 2010

As with Wall St. banks in the fall of 2008, the euro has been deemed "too big to fail" in the spring of 2010.

That's the real message behind the $1-trillion bailout of debt-ridden European countries last weekend by the European Union and the International Monetary Fund. Well, it's only $920 billion U.S., but who's counting? What's $80 billion nowadays? A rounding figure.

The EU is putting in $560 billion in loans to recipient euro-member countries, another $76 billion carried forward from the European Commission, and a further $280 billion from the IMF, whose lending countries include Canada. In response, markets surged worldwide on Monday, with the Paris stock exchange rallying about 10 per cent, while the Dow was up four per cent or 400 points, and the TSX was up 255 points or 2.2 per cent.

A global market panic over Greece's sovereign debt crisis, and the fear it could take other indebted euro countries down with it, had erased all of this year's gains on North American markets in a single week.

European leaders needed to take bold and decisive action, and on the weekend they finally did. Led by Angela Merkel of Germany and Nicolas Sarkozy of France, encouraged by U.S President Barack Obama to do something big, they responded as the U.S. government had in the financial meltdown of 2008. But where Washington was pumping $700 billion of liquidity into a banking system that had seized up, the European leaders were stepping in to restore confidence and stability in the euro as the common currency of most countries on the European continent.

Not that the loans are going to solve the structural deficits and debts of the PIGS - Portugal, Italy, Greece, and Spain, where cultures of entitlement make the Quebec model look positively Darwinian. But it might be enough to shore up the euro, stabilize global markets, and prevent a double-dip recession at a time when the world is just coming out of the worst downturn since the Second World War. Just last Friday, we learned that the Canadian economy created more than 100,000 jobs in April, the largest increase on record, while the U.S. economy added nearly 300,000 jobs.

Perhaps there's something about Mediterranean cultures that differentiates them from the work ethic of northern Europe, an apparent cause of resentment among Germans being asked to underwrite the lifestyle in Greece, where workers can retire at 50, where a third of the economy is underground and even more people don't pay taxes. No wonder the Greek deficit and debt numbers are off the charts. They have an unsustainable economic model of a welfare state unsupported by corporate and personal taxes, and even their value-added tax fails to capture all economic activity.

But leaving aside the Greek mess and its possible tipping- point effects on the neighbours, the euro crisis reflects the inherent contradictions of the European economic model, in a way that was overlooked in the days of Europhoria and the creation of the common currency.

Europe has complete labour-market mobility - for example, a million Polish citizens have migrated to England. It has a single monetary policy for all euro participants - the British did not come in, and must be happy to have maintained the pound sterling and the Bank of England. Yet all euro countries maintain their own fiscal policies, with nominal fiscal disciplines that have been ignored by member states like Greece. Euro countries also maintain borrowing authority to issue their own bonds. Greek bonds last weekend were essentially junk, with buyers demanding premiums of 20 per cent.

So the common currency of the region has been undermined by independent fiscal and borrowing policies. The profligate spending and borrowing of a few countries has endangered the stellar euro brand, and for a few days last week brought global markets back to the brink.

The recent euro experience is a reminder that monetary policy is a key attribute of economic and national sovereignty. In the emergency measures of 2009, Ottawa had the independence to reduce central bank rates to near zero, while putting $40 billion of stimulus into the budget, pumping liquidity into the system through both monetary and fiscal policy. Only the independence of our currency gave the Bank of Canada that margin of monetary discretion.

And the flight of the loonie is a reminder that the value of any currency is based on fiscal fundamentals and the confidence of markets in underlying attribute such as our oil.

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