How to solve European debt crisis? Create a European treasury to back EU bonds

Since the outbreak of the Greek debt crisis, Europe has tried to fix its problems in a stopgap and short-term manner. Not surprisingly, the crisis has continued to widen, threatening not only the individual economies of Ireland and Portugal and possibly Spain, but the European project itself. It is time to address the crux of the matter with systemic change before it is too late.

As it stands now, Europe’s member states have had no choice but to put themselves at the mercy of the financial markets.

The growing needs of modern states have pushed them to borrow increasingly, using ever more risky and sophisticated instruments. Investors have historically bought this sovereign debt because it has been a relatively safe haven. Unlike corporate debt, public bonds imply a guarantee backed by the state’s tax base.

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Yet, just as states create markets which allow them to finance themselves, those markets can turn against the state when the extent of a country’s borrowings leads to doubts about its ability to honor its commitments. As we’ve seen, this can lead to a mortal duel between these two stakeholders, each of which warily watches the other’s moves very carefully as they try to protect their interests.

The worst-case scenario

This is the situation in which Europe finds itself today. The only way out of this dilemma is to restore investor confidence. And that is only achievable by defining a credible path toward the return of sustainable public finances in Europe as a whole.

The euro is not in danger in the short term. It is a solid currency based on the world’s largest integrated economy. However, the monetary union will not be able to survive in the long run unless something is done in the next few months to avoid a chain reaction of defaults among countries in the euro zone.

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The worst-case scenario is all too easy to envision. The most threatened countries will attempt to avoid a catastrophe by adopting austerity programs. However, these will prove to be insufficient to restore investor confidence and ineffective in repelling attacks by speculators, which drive up their borrowing rates. The default dominoes will begin to fall, one after another.

The banks and other financial institutions that have underwritten the devalued debt of defaulting states will fall in turn, causing the ruin of their depositors, pensioners, and salary earners. The European Central Bank (ECB), in turn, will not be able to prevent this disaster. If it does try to do so – for example, by printing more money – the euro will collapse.

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