Martin Wolf, an economics commentator at The Financial Times wrote a very important column recently on the tough choices facing countries in the euro zone.
“The euro zone, as designed, has failed,” Mr. Wolf wrote on May 31. “It was based on a set of principles that have proved unworkable at the first contact with a financial and fiscal crisis.”
One way to summarize his argument is to say that slow-motion bank runs are already in progress on the European periphery, and that these countries’ banking systems are being sustained only by a process in which, say, Ireland’s central bank borrows from the Bundesbank and then lends the funds to Irish private banks to replace the fleeing deposits. The claims among central banks as of the end of last year are shown in the graphic on this page.
You can see why we’re now at the panic stage.
The Bundesbank is already very upset about its large claims on troubled debtors, which are backed by sovereign debt as collateral. Yet if financing stops in the wake of a debt restructuring, the result will be to collapse the debtor nations’ banking systems, a process Mr. Wolf believes would lead to their ejection from the euro. (He makes me look like an optimist!)
“The euro zone confronts a choice between two intolerable options: either default and partial dissolution or open-ended official support,” Mr. Wolf argued. “The existence of this choice proves that an enduring union will at the very least need deeper financial integration and greater fiscal support than was originally envisaged. How will the politics of these choices now play out? I truly have no idea.”
So the European Central Bank keeps saying that restructuring is unthinkable. Yet austerity programs are not working; the prospect of a return to normal financing is receding rather than approaching.
If you ask me, the water level has now dropped so far that the fuel rods are exposed. We really are in meltdown territory.
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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.
Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including "The Return of Depression Economics" (2008) and "The Conscience of a Liberal" (2007). Copyright 2011 The New York Times.