Europe must find a way to give its bailout fund the firepower it needs to become a firewall that will block its financial crisis from spreading, a senior U.S. Treasury Department official said on Thursday.
Testifying before the Senate Finance Committee, Under Secretary for International Affairs Lael Brainard said the 440-billion-euro ($600 billion) European Financial Stability Facility (EFSF) provides "quite substantial resources" that could be given more strength by leveraging it to make it more forceful.
Europe should leverage the EFSF "to be credible in the market, and it needs to give them that overwhelming force where it takes the threat of defaults and bank runs off the table," she said.She added that there were a number of ways of doing so but did not specify a preferred method.
France has argued the most effective way of leveraging the fund is to turn it into a bank that could use funding from the European Central Bank to guarantee some of the debts of struggling euro zone countries. But the ECB and Berlin oppose this and the proposal appears to be dead.
An alternative would use the EFSF to guarantee a portion of potential losses on new euro zone debt and so aim to restore market confidence and convince investors that the debt of Italy and Spain remains safe to buy.
European leaders will use a summit on Sunday to try to work out their differences.
Brainard, who attended a Group of 20 finance ministers' meeting in Paris last week that focused on the European financial crisis, said it posed the most serious risk to the global recovery and also created "headwinds" for a fragile U.S. recovery.
She told lawmakers, in response to questions about chances of overcoming it, that it was "a good sign" that European leaders were "intensively engaged" in trying to come up with a method for containing it.
"I think they know ... this is an issue that the world cares a great deal about," Brainard said, adding it will be "the most important priority" when political leaders from the G20 meet in Cannes, France, on November 3-4.
U.S. FEELING THE IMPACT
Brainard said U.S. interest in Europe's well-being stems partly from the fact that U.S. recovery "remains fragile and all too vulnerable to disruption beyond our shores." More stability in Europe would bolster consumer and investment confidence that was shaken during the summer by a contentious debate over raising the U.S. debt limit and hurt more as the European crisis intensified.
Brainard also pointed to China in discussing what is needed for the global economy to get on sounder footing.
"With demand in the advanced economies likely to remain weak, it is essential for emerging economic powers, such as China, to play a bigger role in bolstering and sustaining global growth," she said.
Countries with big current account surpluses should encourage more domestic consumption, she added, in a further clear reference to China.
She also addressed the value of China's currency, which has been a topic of heated debate in the United States.
Many U.S. lawmakers say China keeps its currency artificially low, giving it an unfair trade advantage. The Senate this month approved legislation to try to force Beijing to let the yuan rise, but Republican leaders in the House of Representatives have signaled opposition to the measure.
Brainard said Treasury has "worked aggressively to pressure China" into letting its yuan currency appreciate more rapidly, which would likely encourage more consumption by Chinese consumers.
"We have seen some progress on this front, with appreciation of over 10 percent in real terms bilaterally since June 2010 and 38 percent since 2005, but more is needed," she said. She said the yuan was still substantially undervalued.
"Our leadership at the international financial institutions could be at risk if Congress does not act to support our commitments to these institutions," she said. "Other nations, particularly China, are eager to take up our shares in these institutions if we do not meet our commitments."