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The Great Unanswered Question About the Eurozone

In a column for the FT today, Wolfgang Munchau lays out what may be the only plausible solution to the Eurozone crisis - for governments like Greece to "default into" the European Stability Mechanism. The ESM could then issue bonds, thereby mutualizing the bad debt of the defaulting governments. The Euro survives, the PIIGS (Portugal, Italy, Ireland, Greece, Spain) get their debt off their books and can rebuild without having to do distasteful things like reform their labor markets, and the Euro project continues with its new Banking Union.

Except...

The great unasked and unanswered question with all of these schemes is: where is the money coming from? That's not the same as the question who will buy this debt. Banks will, of course, if they have a clear idea of where the repayment and yield will come from. If it looks like the debt might not get repaid, they will require too high a yield, and the problem starts again. So who is the ultimate guarantor of this scheme? Together, the PIIGS supposedly contribute 37 percent of the ESM's cash-flow, but that's now, before the defaults which will require a much bigger capacity than the ESM's current E500 billion capacity. France, which contributes 20 percent, is likely going to face similar problems given its likely electoral direction this year (Socialist President elected yesterday, socialist-communist-fascist dominated Parliament likely later in the year). So the answer will be, once again, the German taxpayer.

So the ESM banking union option once again collapses into the basic question -- will the German taxpayer stand paying not just for the debts but the ongoing fiscal health of the profligate PIIGS nations? All indications seem to be no. So, despite being a seemingly plausible solution, the ESM banking union solution is probably doomed to failure too.

Of course, that doesn't mean they won't try it.