A PIG's breakfast

The Greek debt problem has been poorly handled by Europe's decision-makers. Euro-pean Union heads of government, and the European Central Bank, initially rejected the idea of involving the International Monetary Fund, but without a fall-back plan.

It is hard to avoid the conclusion that part of the motivation for this was French President Nicolas Sarkozy's reluctance to see Dominique Strauss-Kahn, the IMF's managing director, ride in from Washington to the rescue of the eurozone. Mr Strauss-Kahn is, of course, likely to be Mr Sarkozy's Socialist rival in the next French presidential election.

Is Greece the "canary in the coalmine" - the warning that tells us that Europe's monetary union is on the verge of dissolution, with the other three of the famous PIGS (Portugal, Italy, and Spain) lining up like dominoes to fall? George Soros fears this might be the case, and gives the eurozone only a 50 per cent chance of survival in its present form.

Certainly, the episode highlighted flaws in the way the euro's governance - flaws that are no surprise to some of those in-volved in creating the common currency. Helmut Kohl, one of the euro's principal parents, said in 1991 that "the idea of sustaining an economic and monetary union over time without political union is a fallacy". Margaret Thatcher, from the opposite camp, said in her memoirs: "I believe the European single currency is bound to fail, economically, politically and indeed socially, although the timing, occasion and consequences are all still unclear." There may now be a market for a Greek translation of her book.

Although they might not agree with either of these two apocalyptic predictions, many of Europe's leaders are coming round to the view that there is a need for change, and that the Greek case has revealed a flaw at the center of the project. Mr Sarkozy, for example, has revived a long-standing French argument for some form of economic government in Europe as a counterweight to the ECB.

The French usually advance this proposal to get some purchase on the ECB's monetary decisions, which they sometimes consider hostile to growth and employment, or in order to prevent other countries from maintaining unfair tax policies ("unfair" usually being defined as a tax rate lower than the relevant French one).

In the past, the Germans brushed these arguments aside, but now they are a little more receptive. German Finance Minister Wolfgang Schäuble, however, focuses on the issue of distressed members, and has advanced a proposal for a European Monetary Fund to provide assistance to countries in Greek-style difficulties, roughly on the IMF model.

This idea has logic behind it. The drawback is that it would require a change in the European treaties, which in turn requires a unanimous decision by 27 countries, and positive votes in referendums in some of them, including the United Kingdom if David Cameron's Conservatives win the upcoming general election there.

In the aftermath of the negative referendum votes in France, the Netherlands, and Ireland on European constitutional reform, it is close to inconceivable that EU heads of government would agree to set off down that path again. Certainly nothing could be achieved on a timetable that would offer any comfort to the other PIGS. They would all be bacon and sausages before any agreement was reached.

So, in the short run, the IMF will have to be used, if that kind of support is needed, and Mr Sarkozy will have to swallow his pride. But is an EMF really what is required in the long run? I think not. Nor do I think that a European economic government is strictly necessary. What is needed, though, is a collective agreement on fiscal discipline, and a revival of the Stability and Growth Pact, which was unwisely abandoned - ironically when the French and Germans found its rules too constraining.

Europe's leaders should refer to a paper by Otmar Issing, "The Euro - A Currency Without a State," published in December 2008, before the debt crisis erupted. Mr Issing, the ECB's chief economist in its formative years, knows more about how a monetary union operates in practice than any man alive. He maintains that "the Stability and Growth Pact contains all the rules that are necessary for Monetary Union to function. There is no need for coordination of macroeconomic policies to go any further than this".

Europe does not need the French plan for coordination of tax policies, or another IMF, but there does need to be fiscal discipline to prevent other countries from free riding, as the Greeks seem to have done. They apparently assumed that the rest of Europe would overlook continuing high deficits, and that, as eurozone members, the market would consider their debt to be just like German bunds, though issued by friendly and welcoming people in an agreeable climate, and with a glass of ouzo on the side.

The original Pact envisaged a three per cent-of-GDP cap on fiscal deficits, save in exceptional circumstances. Investors well understand that we are in such circumstances now, so it will take some time to get back to that level. But that should be the clear aim, with IMF assistance along the way to provide interim funding where necessary and political cover for governments obliged to take tough decisions on public spending and taxation.

Fiscal discipline does not sound as visionary as "economic government." But the EU has suffered from a surfeit of "vision" and a deficit of practical budgetary measures. It is time to redress that balance, or Mr Soros's gloomy prognosis may become reality.

© Project Syndicate, 2010.

www.project-syndicate.org

The author, former chairman of Britain's Financial Services Authority and a former Deputy Governor of the Bank of England, is currently Director of the London School of Economics. His latest book, Banking on the Future: The Fall and Rise of Central Banking, will be published this spring.