Believe it or not, I have been reading up on the Greek/European/World scenario as a way of taking my mind off fingernail-destroying horsetrading over here in Westminster. Yes, those perfidious Europeans used the cover of a protracted UK negotiation over AV Plus to sneak out a 750bn Euro guarantee fund.
Several points are worth making, and most of them are made in the FT today. First, we seem to have had an amazing turnaround from the ECB. Or have we? As Jeremy Warner reported, Axel Weber threatened to shoot Trichet if he so much as mentioned QE.
Quantitative Easing, or buying sovereign bonds, was not discussed at the council meeting. So did this mean that it wasn’t even being considered? “We did not discuss the matter and I have nothing more to say on it”, M. Trichet replied.
Then on Monday we learnt that … the ECB is intervening in private and public debt markets, and according to the FT today, has helped knock huge numbers of points off sovereign bond yields everywhere. But so determined is it to neutralise the monetary effects that it plans to soak up any cash by issuing bills. ‘Tight money’ people must be gnashing. Instead of monetary stimulus, it is carrying out what Greg Ip of the Economist recognises as fiscal policy
This qualifies as fiscal policy because the clear intent is to enable member governments to borrow who otherwise could not. Greece is experiencing a solvency crisis, not a liquidity crisis. The ECB’s balance sheet is thus subsidising the credit risk of a member government.
As Ed Conway of the Telegraph observes, “the ECB has started its QE journey on the worst footing imaginable, appearing to be forced into taking the decision, rather than doing it off its own back.”
Further more, moral hazard is surely a major issue here. That seems to be a theme running through the FT’s extensive comment, who say
That the package was prompted by a market rout, moreover, makes it a European “Greenspan put”. It entrenches moral hazard not just for sovereign borrowers but for a banking sector which, unless radically reformed, will learn to rely on taxpayers coming to the rescue.
But their long leader focuses on a more immediate, pragmatic problem: that of taking big losses.
And liquidity does not equal solvency: buying vulnerable states time to rein in shaky finances does not by itself cut deficits or stabilise debts. Their willingness to push the painful process through remains unproven … There is a real chance that a euro member’s failure to pay its debts will land neighbours or the ECB with losses that can only amount to fiscal transfers or money-printing.
On the subject of that unproven willingness to take pain, Gideon Rachman nails it in Europe is unprepared for Austerity.
I used to think Europe had got it right. Let the US be a military superpower; let China be an economic superpower – Europe would be the lifestyle superpower … As the riots on the streets of Athens illustrate, however, not all Europeans will react so stoically to deep cuts in spending. Many have come to regard early retirement, free public healthcare and generous unemployment benefits, as fundamental rights. They stopped asking, a long time ago, how these things were paid for.
He sees the bailout producing massive political tensions. Too right, just like the banking bailout in the US; one interest group benefiting from another. Toxic. This is the answer to Dave’s naive question about why public services should take the hit.
Simon Johnson and Peter Boone have weighed in with perhaps the most pessimistic take on this. I am currently 2/3 through 13 Bankers (reviewed here**) and so not surprised by their take: that nations behave just like banks in their risk-seeking, cost-off-shouldering selfish behaviour:
Given the incentive problems in the eurozone, it is no wonder more nations want to join – the requirement is just to appear prudent for a few years. No wonder also that it blew up. Nations with profligate governments or weak financial systems have a bonanza; overall, this system encourages a “race to the bottom” – led by governments in smaller countries, which relax fiscal and credit standards to win re-election (or just to enjoy a boom). They borrowed funds from the (unnaturally) less profligate in the eurozone. The Germans were austere; the periphery enjoyed the boom.
They are concerned about moral hazard above all: this bailout sends out terrible signals.
this weekend’s actions jammed open the ECB credit window and send a clear message to creditors: you can again lend to the profligate without risk. Such emergency measures actually further undermine any government’s willingness to address its solvency issues.
Perhaps the most important message from the whole crisis is that those who lend to the profligate and foolish need to take some pain as well. But this makes for an awkward result: capital costing more, which has costs everywhere.
Above all this European crisis is about solvency not just liquidity. Punning: liquidity problems can be solved, solvency issues can’t be washed away. For that you need growth*. So, finally, Munchau needs to get a word in that seems to tie together both matters: how this influences future reforms, how it is a liquidity solution to deeper issues.
How can a loan guarantee solve a problem of excessive indebtedness? It surely saved the eurozone, which might otherwise have been pushed over the brink this week. But beyond this week, the benefits are less clear. At best, it provides sufficient stability to allow Spain and Portugal to press ahead with reforms. So the judgment about the success of this programme depends critically on whether the two countries can reform their labour markets, sort out their banking sectors, improve productivity and speed up fiscal adjustments
UPDATE: I would like to draw attention to the article linked to by Luis (see comment below). The bottom line: debt restructuring would not work right now.
*On that issue, here is another sliver of hope: manufacturing in the UK seems to be growing fast.
**I tend to agree with the FT reviewer: that Johnson & Kwak have written an excellent book that nevertheless overstates its case, particularly in terms of how much the sinful players in this game have actively anticipated the costs of their actions landing on others.