Opening Remarks

Bloomberg View: A Powell Doctrine for Europe; Alternative Energy Needs Storage


FIGHTING EUROPE’S CRISIS WITH OVERWHELMING FORCE

Europe is heading for what could be the last stand in its two-year-old sovereign debt crisis. By the time the Group of 20 nations holds its summit in Cannes, France, on Nov. 3-4, the European Union aims to have a rescue plan sound enough to ensure the financial troubles of struggling governments don’t bring down the banking system.

Achieving credibility will require three things Europe’s leaders have so far failed to do. They must discard the illusion that certain euro-area governments, particularly Greece, can afford to pay their debts. They must provide a realistic accounting of how much Europe’s banks will lose when those governments default. And they must offer financial guarantees large enough to convince markets that the defaults and the losses will be final.

How much, then, will it cost to stop the rot? The first key question is which European governments need to default on their debts. Greece is clearly in the worst shape. At current interest rates, and given growth forecasts from the International Monetary Fund, Greece would have to run a primary budget surplus (not counting debt-service payments) of more than 5 percent of gross domestic product just to keep its debt burden from growing. Portugal can’t afford to pay market interest rates and would probably need many years to get its debt down to a level low enough to restore investor confidence. Ireland, Italy, Spain, Belgium, and France can stabilize their debt burdens with primary surpluses of less than 2 percent of gross domestic product, assuming jittery markets don’t push up their interest costs. Such surpluses are well within the historical range, suggesting the bloodletting could end at Greece and Portugal.

The next question is how much debt insolvent governments can actually afford to pay. If we assume that a primary budget surplus of about 1 percent of GDP is sustainable, and that European guarantees would allow the governments to borrow at reasonable rates after defaulting, Greece would need a 70 percent writedown, after which holders of its bonds would be left with securities worth only 30 percent of face value. The required writedown for Portugal would be 40 percent. The market seems to recognize this: The countries’ 10-year bonds are trading at discounts of about 60 percent and 40 percent, respectively.

The two defaults would wipe out about €300 billion ($416 billion) in Greek and Portuguese debt, a large share of which is held by banks that are pretending it’s worth full face value. Hence, current estimates of the fresh capital needed to prop up the banking system—such as the International Monetary Fund’s €300 billion—seem reasonable. Governments will have to be prepared to provide that capital, though banks might ultimately raise a large portion themselves, and some financial institutions might be allowed to fail.

The European Financial Stability Facility and the European Central Bank, with the collective backing of euro-area governments and possibly the IMF, would have to guarantee all new bonds issued by Greece, Portugal, Ireland, Spain, Italy, France, and Belgium for several years—or until a more permanent fix, such as jointly issued euro bonds, can be arranged. Data compiled by Bloomberg and separately by the IMF suggest those countries’ financing needs add up to some €2.5 trillion through 2015. Adding some buffer for error, €3 trillion would be the minimum amount that European governments must pledge to stop the crisis. It’s a staggering amount. But a show of overwhelming force is the only way to put a stop to the crisis.

IT’S NOT ENOUGH TO HARNESS THE WIND. WE HAVE TO STORE IT, TOO

Arguments for solar and wind power are so enticing (endless availability, no pollution, and so on) that it’s easy to see why the idea of transitioning the world economy to alternative energy over the next 40 years keeps gaining favor. Public discussion often makes it seem as if the only obstacles are efficiency and cost. Photovoltaic solar cells and offshore wind farms can provide power at about $160 a megawatt hour. That’s far costlier than coal-fired plants, which deliver power at about $70 a megawatt hour. That price gap keeps narrowing; it may close completely in a decade or two.

Recent events in Germany, though, highlight a less discussed, but equally crucial, challenge. German energy prices have begun careening in the strangest ways. Sunny, gusty days generate so much alternative energy that utilities pay industrial customers to take it away. Cloudy, calm weather creates shortages that can send wholesale prices as high as $220 a megawatt hour. Zigzagging energy prices aren’t just a short-term annoyance. They distort budgets and spending priorities, forcing utilities to spend billions on fossil-fuel plants that are used only part-time to ensure steady power when wind and solar are in short supply.

The most elegant solution would be to improve grid-level storage of solar and wind power, so yesterday’s sunshine can continue to yield power during today’s storms. Achieving next-generation storage will take years. False starts will abound. Partial breakthroughs will need to be freely shared. Such long-horizon projects are anathema to the private sector, but well-suited to government support. The U.S. Energy Dept. took a step in the right direction last month when it issued a slew of $3 million or smaller grants to labs exploring projects as varied as molten batteries, nanomaterials, high-temperature salts, and compressed vapor.

Alternative energy’s potential goes well beyond the approaches being commercialized today. The sooner major advances in areas such as storage can be found, the easier it will be to save billions by shrinking the need for backup plants.

To read William D. Cohan on universal Fed-bashing and Alice Schroeder on ubiquitous “black swans,” go to: Bloomberg.com/view.

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