Monday, 30 July 2012

Whatever it takes!

In spite of 20 saving-the-Euro EU summits held these last three years ( since the Greek problem surfaced) the Euro monetary system is still very much in danger of blowing itself out of existence.

Basically to put it in simple language it is unsustainable that countries like Germany at the virtuous extreme and Greece at the vicious extreme, with fifteen other nations in between sharing the same currency but moving at very different economic speeds, can keep within a monetary union that denies the exchange rate adjustment to render competitive those who have lost it, and to render less competitive those who have become super-competitive.

Last Thursday with the Euro edging too closely towards the abyss ( best reflected by the high rates that Spain and Italy are being forced to pay for their borrowing whilst Germany can borrow at zero real cost) ECB President Mario Draghi has declared in plain and simple language that the ECB will do whatever it takes to save the Euro.

Mr Draghi assertive pronouncement was temporarily discredited by its main constituent member the German Central Bank who expressed itself against any monetary initiatives to help Spain and Italy arguing that this would take away the political pressure for these countries to reform their economies.

However before the day was out a joint statement by the German Chancellor Merkel and the French President Hollande basically backed Draghi and said they also are prepared to do politically whatever it takes to save the Euro.   Again over the weekend Mrs Merkel made a similar joint statement this time in tandem with the Italian Premier Monti.

Something has changed and the mood on the markets has turned distinctly positive since Draghi's statement.    What appears to have changed is that Mrs Merkel appears to have decided to overrule the German Central Bank's objections and sent a signal to the ECB governing council that they can proceed with extraordinary measures to bring down the rate of borrowing for Spain and Italy.

This is a welcome political initiative.   There is no way in the world that Spain and Italy can continue with their economic reform programme if the savings from their austerity measures are lost in paying higher interest on debt servicing.   Democracy will not tolerate several rounds of austerity measures without delivery of results showing there is light at the end of the tunnel, and serial rounds of austerity which lead to depression rather than growth will inevitably lead to the democratic election of extreme forces of the right or left with little or no respect for the democratic rule of law.  It happened in Germany in 1933 and there is no reason to think that a different result will be obtained this time if the same methodology is adopted.

But it is necessary to define what the various actor ought to mean when they say ' whatever it takes'.

For the ECB whatever it takes ought to mean using whatever unorthodox monetary measures are necessary to stabilise the markets through large scale monetisation.   Unfortunately this is a taboo for most inflation sensitive central bankers in general and the Deutsche Bundesbank in particular given the hyperinflation Germany went through in the first half of the 20th century.   But now the problem is not inflation.  Now the problem is prolonged recession risking a depression and a large dose of monetisation is needed to keep prices stable from downside risks.   If such measures are successful and instead of having 2% inflation we would have say 4% inflation it will not be the end of the world either.   The world has handled successfully much higher inflation in the past and a somewhat higher dose of inflation will work wonders to ease the burden of debt that had to be created following the financial crisis of 2008.

But whatever extraordinary measures the ECB can take, from direct bond buying of Italian and Spanish bonds, to lending to the European Monetary Stability Fund to do so following it being licensed as a bank, from easy long term loans to banks to enable them to buy their governments' securities to further reduction of across the board interest rates, none of these measures could be considered as a permanent solution to the Euro crisis.   At best these measures if successful would gain precious time for the politicians to do their part of the 'whatever it takes'.

And frankly this political 'whatever it takes' is fraught with all the problems of having 17 or 27 countries agreeing on a common course of action.   What is the ideal 'political whatever it takes'?

That will be in my next contribution later on this week.


  1. 1. Bernanke / Geithner / Paulson -- 2008

    2. Trichet / van Rompuy / Barosso -- 2011

    If you judge a currency by the quality of its management the Euro will certainly fail.

  2. Fair point. But I think one must give credit to Draghi who since taking over a very precarious situation from Trichet has been following a more active and effective monetary policy against all the obstacles put in his way by the German BundesBank.