Sunday, 10 April 2011

Trichets Legacy

The Malta Independent on Sunday

Awesome events are happening around us: acts of God as much as acts of man.

This last year we have seen natural disasters we don’t normally see in a decade. Major earthquakes in Haiti, Chile, New Zealand (twice), and Japan (twice and counting), a devastating tsunami in Japan causing the breakdown of a nuclear power station complex that is malfunction and threatening large scale contamination, a freezing winter in the northern hemisphere which left many countries snow-bound for days, floods in Eastern Australia and bush fires on the western side, mud slides in Brazil were among the main natural disasters.

Acts of man have been equally breathtaking since a vegetable hawker set himself on fire in southern Tunisia on 17 December last year in protest against the heavy hand of the state when dealing with the powerless individual trying to earn a decent living for his family. The popular uprisings in Tunisia and Egypt delivered the beacon to protesters for democracy within a relatively short time and with relatively little cost in terms of human life, as the military in both cases defended the people rather than the autocrat.

Inspired by this success, other countries with a superficial or non-existent democracy assumed that the momentum of the Arab spring could wipe out their own autocratic structures with the same relative ease as in Tunisia and Egypt.

That was a wrong assumption. In Libya, the army, for reasons it know best, largely remained loyal to the incumbent rulers and landed the country in a civil war with the eastern part controlled by the pro-democracy rebels and the western part in the hands of the incumbent regime. UN sanctioned military intervention, effective in reversing the regime military machine, which was clearly both capable and intended to slaughter the rebels in the east, has largely resulted in a stalemate with the battle front moving a few kilometres backward and forward with monotonous regularity.

Other uprisings in the Middle East and the Gulf are proving much more muted and there seems little appetite by the international community to support any movement that upsets the status quo. Firstly, there is a digestion problem. The powers that be can’t handle so many burning issues simultaneously. Secondly, the Gulf and the Middle East are not North Africa. North Africa is not a major oil exporter, whereas if there should be a disruption of oil exports from the Gulf, the price of oil would explode through a supply shock and western economies would be thrown back into a deep recession while still recovering from the financial crisis of 2008. Thirdly, the five countries that form North Africa are not closely clustered like in the Middle East and the Gulf.

So the revolution in North Africa could happen in series. In the Middle East and the Gulf any instability could spread like wild fire involving religious wars and friends like Israel as much as foes like Iran.

A third dimension of the awesome events that unfolded during the past 12 months is the grave financial difficulties being encountered by sovereign states in the euro area. Unable to regain competitiveness through the devaluation route, which is no longer available in a monetary union, Greece, Ireland and Portugal, would have defaulted on their debts without the support of other EU countries who put together emergency funding to replace the funding that was being denied them by normal capital markets.

These events have exposed a grave malaise of delusional denial among many international leaders, be they political, financial or business. Political incumbents active on one side of an internal civil war convince themselves that they are still loved by their people, whom they perceive as eternally grateful for past achievements. In their eyes, the rebels, rather than democratic elements seeking freedom from long-term political oppression, are mere disgraceful traitors in the service of foreign forces.

Peripheral euro area countries like Greece and Portugal have lost competitiveness because their political leaders used their experience within the euro merely to lower their borrowing costs so that they could persist in their old overspending habits. Now that markets are pricing their borrowing requirements on their fundamentals rather than their euro linkages, they can only regain competitiveness through overdue, persistent and painful restructuring.

This is only possible through substantial economic growth, which in turn depends on recovery of competitiveness. It seems like a circular problem to me, which in the end has to be broken by what will hopefully be an orderly debt restructuring that will lighten the debt load through market measures rather than a dirty default. Yet these euro area peripheral leaders continue to pretend or delude themselves that they can service the mountain of debt they wastefully created in the first place. Perhaps they need reminding what James Carville, once political guru to President Clinton and until recently CNN contributor, had said about the feebleness of extravagant borrowers facing the bond market: “I used to think that if there was reincarnation I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

Two people have kept their cool during the awesomely difficult times we have experienced since the financial crisis of 2008. They are the two main central bankers on both sides of the Atlantic, Bernanke in the US and Trichet in the euro area. Both men have filled the gaps that politicians could just not move fast enough to address. Were it not for their ingenious and timely intervention, we would have had a massive financial disaster of Great Depression proportions.

Trichet is probably edging out as the overall winner supporting euro area banks with massive liquidity backing, as the troubles of their sovereigns affect negatively banks’ normal access to the markets. He even engineered temporary support for sovereign bonds to keep yields within acceptable boundaries until the politicians build permanent structures more appropriate for such role. Doing this against the opposition of the German boy on the Board and at the same time being courageous enough to start raising interest rates when other central banks would not even dare think about it, shows Trichet’s mettle in protecting the credibility of the ECB to underpin the continued mooring of inflation expectations at low levels.

When Trichet leaves next October he will be a hard act to follow. No one around has the status to fill the void left by politicians and at the same time not just keep his independence from them but even use domestic banks’ dependence on ECB support to force the hand of politicians to do what needs to be done no matter how politically unpalatable it could be. Trichet leaves a legacy that should make him an ideal candidate for Commission Presidency when Barroso’s term is up.

No one has his ability and personality to knock heads of EU national leaders to secure timely, pre-emptive and effective compromises without getting to the very brink of the crisis.


No comments:

Post a Comment