A Currency Crisis Debate: 'The Euro-Zone Bailout Programs Must Be Stopped'

SPIEGEL: Mr. Starbatty, Mr. Bofinger, can the euro still be saved?

Starbatty: All of the measures that are currently planned take effect in the long term. But rescue measures are needed now. That's why many politicians want to pull out the so-called bazooka and inject money into the market through the European Central Bank (ECB) or introduce euro bonds. Both are deadly sins. It would be better to shrink the monetary union to a hard core that can sustain the euro.

Bofinger: That would be a disaster. But I agree with you that time is of the essence. The highly indebted countries must be able to borrow at moderate interest rates so they don't go bankrupt. This could be achieved with euro bonds. And if they can't be implemented that quickly, the ECB has to stabilize the system. In doing so, it would not create inflation but would in fact avoid deflation.

SPIEGEL: Aren't you worried that the pressure to push through austerity and reforms would subside as soon as the ECB unpacked the bazooka?

Bofinger: German politicians have not acknowledged that these countries have already reduced their deficits significantly. Compared to 2009, deficits have declined in all of the crisis-ridden countries. And Italy is the second-most solid G-7 member state, just behind Germany. The markets haven't even noticed this.

Starbatty: Politicians want to buy time for the debtor countries by lending them money, hoping to get it back when these countries recover. But this strategy doesn't work. The markets know that and are driving up yields.

SPIEGEL: Yields are going up because investors are selling the bonds. How can this investor flight be stopped?

Starbatty: Because the trouble spots in the euro zone are not being isolated, the sparks are jumping over to the healthy countries. Everyone knows that if the weaker countries are to be rescued, two countries -- Germany and France -- will ultimately be doing all the heavy lifting. So the most important question is: How long are the Germans willing to pay? And how long are the French in a position to pay? Investors believe that it won't be much longer, and so do the rating agencies.

Bofinger: You correctly describe how the euro zone behaves today, with 17 different countries trying to address the problems individually. In fact, the real question is whether Germany can be everyone's guarantor in the end. That's why we have to turn things around and say: We will now act as a unit. If Italy can go into debt through euro bonds, it will always be able to raise money, even it has to refinance €300 billion ($400 billion) in debt next year. This deprives speculators of the ability to play off individual countries against one another.

Starbatty: I'll say it again: I think this is a deadly sin. A community of liability always results in the careless handling of other people's money.

Bofinger: Of course, the bonds have to be tied to stricter requirements for fiscal discipline.

Starbatty: We had a fixed rule: the no-bailout clause…

SPIEGEL: …which states that no euro country can be liable for the debts of another.

Starbatty: But this rule has been pushed aside. Madame Christine Lagarde, the former French finance minister, says that we violated the treaty to rescue the euro. And that would happen again.

Bofinger: I don't think so, not if the rules are well made.

Starbatty: I think you're a little naïve. People will introduce new budget rules to get euro bonds, and as soon as they have them, they'll forget about the rules the next time there's a problem.

Bofinger: With euro bonds, it would be much more difficult to destabilize the system. Once everything is safeguarded, I can, if necessary, throw out all the countries that don't abide by the rules. For example, each country would have to have its budget approved by European Parliament. If the fiscal policy were viewed as inadequate, surcharges could be imposed on national taxes.

SPIEGEL: That would amount to a fiscal union.

Bofinger: We wouldn't even have to go that far. Temporary surcharges on income and value-added tax would be enough. This possibility would have to be enshrined in the national constitutions.

SPIEGEL: That, however, would require amending the national constitutions.

Bofinger: I believe that in return for euro bonds, most countries would be willing to agree to that.

Starbatty: You're always saying "could" and "ought to." Such normative sentences are unconvincing to an economist, who works with facts. So far, it has always been shown that rules haven't shaped behavior, but that in fact behavior has affected the rules.

Bofinger: If there is no confidence in the political process, then allowing the whole thing to blow up would be the logical next step. Because the market is not working as a tool of discipline. The market is chaotic. Up to 2008, it didn't see what was going on in Greece, and then it woke up. Now it hasn't noticed that countries have reduced their deficits; in fact, it is not differentiating at all.

Starbatty: You get into trouble when you try to eliminate the laws of economics. I can tell you what will happen when your euro bonds arrive. After two or three months, you'll face the same problems as before.

SPIEGEL: So the ECB will have to bring out the bazooka, after all?

Starbatty: Inflation is always the long-term consequence of government financing through the central bank. If the ECB takes the same amount of paper and simply prints larger numbers on it, it is tantamount to counterfeiting.

Bofinger: Where would money be printed? What are you talking about?

Starbatty: The bazooka means nothing other than printing money.

Bofinger: If the ECB buys bonds from a commercial bank, that bank receives a credit to its account with the ECB. Not a single euro is printed in such a case. Inflation could only occur if the bank, given the low interest rate on its deposit with the central bank, started issuing loans on a large scale. The way the economy is developing, banks are not about to start throwing around loans. But even if they do, the ECB can raise interest rates at any time to curb lending.

Starbatty: The central bank is forbidden by law to finance countries directly. Of course, it depends on the economic circumstances, but in the long run the counterfeiting will lead to inflation. In the past, if a ruler minted twice as many coins from a certain amount of treasure or gold or whatever, they were worth less. What the ECB is supposed to do is exactly the same thing.

Bofinger: You're talking about a growing money supply. But what the ECB is doing doesn't increase the money supply. It only increases when the banks issue more loans. Besides, what the ECB is doing isn't prohibited. These are classic open market operations, and not direct purchases of new government bonds.

SPIEGEL: If the investor flight from government bonds continues, the ECB will likely be unable to avoid underwriting government bonds directly.

Bofinger: The ECB only has to signal that it won't allow the interest rates on these bonds to go above 5 percent. It can control this through the secondary market.

Starbatty: I think the use of euro bonds and the use of the bazooka are dangerous. You think they're great.

Bofinger: No, I'm just saying that we're in a situation like the one we had in the fall of 2008. The financial system has to be stabilized directly, and then the rules have to be changed as quickly as possible. But tell me what it is that you want!

Starbatty: Consolidation of the euro!

Bofinger: Whom? How?