More than ever the Euro seems like a slow motion train wreck. If Greece leaves or gets ejected the permanency of the Euro gets questioned and investors start asking whose next. If Greece stays the instability we have been living with will persist till the next showdown so the crash could be postponed but not avoided.
What can be done to avoid this slow motion train wreck which will cause great instability in financial markets and could lead to a long recession, if not a depression with possible challenges to the normal functioning of democracies in distressed countries?
Everybody now seems to be agreeing that the Euro cannot survive as a monetary union in isolation unless it is backed by fiscal transfers mechanism and a Euro-wide bank regulation and deposit insurance protection. Essentially this means the creation of a fiscal union with migration of sovereignty over fiscal matters from the individual countries to a centralised organisation and offering scope for the issue of mutualised debts in the form of Eurobonds on the collective responsibility of all Euro members.
These are political decisions that cannot be taken overnight. Apart from requiring parliamentary ratification of 17 member state parliaments, in some cases they would require national referendum and possibly changes to the national Constitution. Putting all this to fit the electoral calendar and sensitivities of many countries one can understand that the objective of a fiscal union and Euro bonds is necessarily at best a medium term objective.
So the question is how can time be gained to avoid the train wreck? How can time be given to Europe's political leaders to deliver a fiscal union and a central debt agency capable of issuing Euro bonds on collective responsibility so that individual Euro area member countries will no longer borrow their funding needs directly?
These are the questions that must be answered if the slow motion train wreck is to be avoided.
There is only one institution that has the autonomy and resources to take initiatives to postpone the train wreck to allow time for Europe's politicians to do what can no longer be avoided. Essentially to take the European integration project to the next level from monetary union to fiscal union and eventually to a political union as the United States of Europe!
That institution is the European Central Bank (ECB). The ECB has to be ready to do three things to avoid the train wreck irrespective of whether Greece stays or goes.
- Huge, may be unlimited, liquidity injection initiatives to ensure that banks in all Euro countries have all the necessary liquidity to meet and nip in the bud any loss of confidence by depositors because of events in Greece. This has to be on the same lines of the recent LTRO may be renamed LerTRO meaning Longer Term Refinance Operation as the term gets increased from three to five years and the collateral requirement relaxed even further.
- Display of readiness to intervene directly in the bond markets through its Securities Market Programme (SMP) to keep within serviceable limits yields on bonds of countries undergoing and adhering to austerity programmes. No country can stay on course with austerity and restructuring if the savings made through austerity have to be paid out in higher borrowing costs.
- Launch of a huge fund (sourced by government contributions from fiscally strong countries and through monetisation by the ECB) whereby the EIB or the ESM will supply fresh capital to EU banks that are judged insolvent not merely illiquid. This especially applies to Cyprus, given its exposure to Greece, and to Spain given the bad assets still lying on its banks’ books.
Something has to give. BuBa will have to break out of their mind-set and consider what the economic consequences for Germany would be if the Euro breaks up and Germany would have to revert to the Deutsche Mark.
BuBa strict monetarist approach that monetisation will lead to inflation is a fallacy out of tune with current realities. The monetisation incurred through these non-conventional measures will not lead to increased spending in the economy where the velocity of circulation of money has dropped dramatically and the normal banking system is not creating money through the normal lending process. Banks in distress are no longer in the business of lending money.
Furthermore all these measures are reversible. Just as in the US the TARP measures were reversed with little or no cost to the taxpayer and with clear positive impact on the recovery, the non-conventional measures explained above can be reversed when we get to post-crisis mode. The SMP and LTRO programmes can be reversed. The recapitalisation fund can be wound down when circumstances permit banks to repay their extraordinary funding ( through redemption of Preference Shares) or through privatisation ( through sale of ordinary capital).