A fork in the road for the euro?
There is no middle way to resolving the problems of the euro. That is the most explosive message of this week's report on the eurozone from the IMF, though you might have to be Angela Merkel or Nicolas Sarkozy to get the full effect.
Commentators understandably jumped on the Fund's warning. The press release accompanying the report suggested that the continued tensions over sovereign debt "constitute a key risk to the outlook, with possible large regional and global implications," and that "market participants remain unconvinced that a sustainable solution is at hand".
But that is simply a statement of reality. As I said on the Today programme this morning, more interesting were the ambitious proposals in the longer staff report for finally putting market concerns to rest.
It has long been said that the eurozone faced a choice in this crisis between coming together - and breaking apart. At the end of last year, Chancellor Merkel and President Sarkozy said emphatically that they would hold it together. But in practice they have continued the previous strategy of attempting to muddle through.
What has happened in the past week or so is that it has become clear - to the IMF, to the Obama administration, and to many other interested parties - that the muddle-through option is not viable. Worse that that, it is counterproductive.
Why? Because in the process of muddling through you create so much uncertainty you actively cause the contagion you're trying to prevent.
This has been crystallised in what has happened to Italian and Spanish bond yields in the past 10 days. Uncertainty breeds market concern. Market concern breeds higher interest rates. Higher interest rates mean that economic strategies and debt levels that look plausible with a reasonable cost of borrowing start to look like a crisis waiting to happen.
This is what you get when you half-talk about guaranteeing sovereign debt, and half-talk about private sector burden-sharing, and half-talk about the possibility of restructuring sovereign debt. If you're going to do these things, the message of the IMF's report - and perhaps everything that's happened in the past year - is that you have to go all the way.
What does that mean, in practice? First, and most obvious, eurozone leaders need to do tomorrow what they have already said they will do: notably, resolve their differences over private sector involvement in the next Greek bail-out, expand the EFSF and follow up on the stress tests by recapitalising banks.
But that is just the beginning of an ambitious to-do list from the Fund, which starts from recognising, in the words of the staff report, that "incomplete economic and financial and fiscal integration is casting a shadow on the future of Economic and Monetary Union".
It goes on: "National policy makers in the euro area need to move away from the illusion that a national approach to fiscal, financial and structural issues, preserves sovereignty in a monetary union. Instead they should focus on on the fact that interconnectedness requires more common thinking from an area wide perspective."
That means moving many more steps in the direction of a fully-fledged fiscal union, with, among other things:
- A much larger, more flexible EFSF, able to intervene in secondary markets and effectively stand behind member country sovereign debt.
- "Shared competence" over fiscal policy for countries that are in breach of eurozone roles
- A larger budget for the eurozone, managed from the centre.
- The development of common European sovereign bonds (or Eurobonds).
Something very close to this is necessary, in the IMF's view, to manage this and future crises and build a stable single currency area. But, as the staff primly admit, "the current political economy is divided on the need for such an approach".
You can say that again.
The French Finance Minister, Francois Baroin, has talked today about the need for a "strong message" to come out of tomorrow's special summit. It's safe to assume that a sweeping manifesto for fiscal union is not quite what he had in mind. And, to be fair, it's probably not what the markets are looking for, either.
But everyone will be looking to see some real substance to go with Angela Merkel's promise, at the start of this year, to "do what it takes to safeguard the the stability of the euro area".
Even if it could be agreed, I'm not sure that a bank levy to extract 30bn euros from the financial system, in the name of "private sector burden-sharing", really fits that description. Especially when, quite apart from the obvious, practical difficulties, such a levy could actually undermine the market discipline that the German Chancellor supposedly wants to promote.