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Can Russia Help the Eurozone out of Crisis?

Russia’s economic role will more likely be to create demand for products and services produced in the EU, along with other emerging markets fulfilling their WTO commitments. To do that, Russia needs special agreements with the European Union, which effectively operates as a customs union.

The last days of 2011 have been marked by a series of measures taken by the eurozone countries, referred to collectively as the stability package. In the medium to long term, this may lead to the establishment of supranational financial regulators mainly to oversee member countries’ budgetary and fiscal policies, or at least increase the degree of coordination among the countries’ budgetary policies. The countries have made commitments to maintain budgetary discipline, gradually cut deficits, and curb the growth of their sovereign debts.

Most discussions of this topic seem to overlook the fact that these new decisions generally rehash commitments already made under the Maastricht Treaty, such as keeping budget deficits below 3% of GDP. In reality, however, these agreements were never observed. Without a mechanism to monitor compliance and penalize violators, simply repeating these old commitments clearly will not solve the current financial problems.

For now there is no serious discussion of having national budgetary policies approved by Brussels, and national parliaments likely would never ratify such a move. This means the eurozone has yet to find a way out of the crisis.

Moreover, short-term tensions persist in the eurozone. In January 2012, many countries including Italy, Spain, and Ireland are due to make debt payments. They expect to raise the money by issuing more bonds. Many countries have proposed issuing international bonds such as Eurobonds. This option was rejected by the German and French governments.

This leaves only one option, something that many economists including myself have been suggesting over the last few years. I am referring to the intensive use of European Central Bank (ECB) funds to buy up the bonds previously issued by countries that have amassed huge sovereign debts. This decision cannot be implemented directly because it is in conflict with the agreement that established the ECB, which contained an explicit ban on buying bonds directly from governments.

Therefore, a different mechanism is being introduced: treasury bonds are being acquired from banks as part of bank bailout efforts. This mechanism is gradually gaining momentum, similar to what is being done by the U.S. Federal Reserve. It is a form of quantitative easing – injecting money into eurozone economies in the euro format. The money categories M1 and M2 will grow significantly. Cash supply will likely become excessive relative to the real demand generated by the economy. As a result, a possible outcome for the eurozone includes stagnation or even recession in a number of countries, with an accelerated rise in prices.

This, to some extent, can help resolve the debt problem, because inflation also denominates debt, thereby reducing the debt burden. If a country does not take on new debt and maintains the same inflation level, old debt becomes less burdensome. At the same time, the real value of government spending also declines, which means that the same amount of money buys less goods and services.

Consequently, Europe’s social policies will experience double pressure from recession and inflation. As a result, what used to be proudly described as “social Europe” – a standard many other countries aspired to – will become diluted and eventually cease to exist. Still, it is clear that Europe will have a higher standard of living than many countries, providing enough social assistance to underprivileged population groups. But more and more benefits, such as pensions and medical insurance, will become available only at a specific age, after a person has paid social insurance contributions into social funds for years – not as the free subsidy it is now. This trend will assert itself in the next decade.

In this situation, Russia’s involvement in addressing these problems is unlikely to make any tangible difference, because even balancing the budget of such a small country like Greece requires injections exceeding 200 billion euros. This far exceeds any reasonable contribution Russia could make. So Russia’s economic role will more likely be to create demand for products and services produced in the EU, along with other emerging markets fulfilling their WTO commitments. To do that, Russia needs special agreements with the European Union, which effectively operates as a customs union. Therefore, the Customs Union of Russia, Belarus and Kazakhstan needs to establish a special trade regime with the European Union, similar to the European Free Trade Association. This could make a real contribution to solving the European economic problems.

Views expressed are of individual Members and Contributors, rather than the Club's, unless explicitly stated otherwise.