Analysis: What can Europe do to relieve US crisis?

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(chinadaily.com.cn)
Updated: 2008-10-03 16:08

With the recent Emergency Economic Stabilization Act, the US government is calling on foreign governments and central banks to help bail out troubled American financial institutions, in a joint endeavor to safeguard financial stability around the globe. Yet “none of the other six G-7 members will adopt a similar program to the US”, said, eer Steinbrück, the German Finance Minister, at a teleconference among G-7 finance ministers and central bank governors on September 22.

As allies of the United States, why did Europe refuse to join the rescue plan? The answer would be clear if we look into the economic, currency and political connections among EU members.

-- EU member states have difficulty in joining the rescue

Firstly, significant EU-level decisions can only be made with consensus among all member states, which now comprise 27. Such a decision-making mechanism makes EU a miniature “United Nations”, where consensus is difficult to reach such as whether EU member states should participate in the rescue, where to find the huge funding source for the bailout, what plan to carry through, and how EU member states share the rescue cost. This left barely any probability for a joint EU bailout. Meanwhile, the 3 percent budget deficit ceiling and 60 percent public debt ceiling set in the Maastricht Treaty also constrained EU's ability to join in the rescue.

Secondly, although EU as a whole has become a larger economy than the US', the European Central Bank and member countries have no need to hold huge foreign exchange reserves, given their currency integration in the Eurozone. By the end of July 2008, the ECB's foreign exchange reserves registered just US$62.9 billion, and reserves of all Eurozone countries added up to a mere US$555.1 billion, most of which reserved for the settlement of international trade and financial transactions. Barely any reserves are available for the US bailout program.

Moreover, as the financial crisis rippled to Europe, EU members have shifted the focus of their policies toward domestic financial stability. Europe's banking sector has recently seen lingering crises; Belgium, UK, Germany and France have been forced to recapitalize their banks, such as Fortis, Northern Rock and others. Analyses suggest that Europe's banking sector will face tremendous refinancing pressure in the two years to come, as Europe's 30 biggest financial institutions see their one-trillion-plus dollars of debts due in the coming 15 months. European governments and ECB are running out of wits just keeping themselves out of the turmoil.

-- Measures that EU may take

First, the EU can pressure the US government to assume the responsibility and get the bailout plan approved the soonest possible, in order to prevent further contagion of the financial crisis. Second, EU member states will take decisive actions to avoid impact from the crisis.

With its currency system and political structures, the EU is unable to take a joint action in response to a Europe-wide financial crisis. As an example, the German Finance Minister Peer Steinbrück disagreed with a 300-billion-euro rescue package for the banking sector proposed by his French counterpart Christine Lagarde, who later denied the plan. Therefore, to halt the contagion, all member states have taken rapid and bold measures against potential domestic crises, including partially nationalizing troubled financial institutions through recapitalization from government budgets, and fully guaranteeing the debts of major financial institutions (the Irish model).

In history, EU countries have not shunned government intervention and nationalization of private companies, or government guarantee for financial institutions. Successful cases include the bailout of Credit Lyonnais by the French government in the 1980s, and the temporary nationalization of troubled financial institutions in Nordic countries in the 1990s. Therefore, EU countries will mainly employ these measures when they have to rescue their troubled institutions.

Third, financial rescue programs in different EU members will influence each other, or even force governments to take similar actions respectively. On September 30, to prevent a bank-run, the Irish government announced its plan to guarantee all debts of six major domestic banks. This move certainly stabilized the domestic credit market, but because of the free cross-border flow of cash, it would also draw depositors and borrowers from other EU members, creating an unfair advantage for Irish financial institutions. Other member states, while negotiating with Ireland, promptly launched protective actions. For example, UK, to assure depositors, raised the threshold for guaranteed deposits from £35,000 to £50,000.

In a word, with each member state merely capable of protecting themselves against the contagion of crisis, EU has more sympathy than remedy to offer for the ongoing American financial crisis.