Germany will inevitably face final choice on euro zone cure
There is an ‘all roads lead to Frankfurt’ certainty about the solution to the debt crisis
YOU HAVE probably heard the joke by now. Paddy Irishman, Paddy Portuguese and Paddy the Greek go into a bar and order a round. Who pays? The Germans!
As with any good joke there has to be a grain of truth in it, and if Michael Noonan’s comments of last week are any guide to official thinking, it is not too far away from this position. Asked about the debt crisis last week, the Minister for Finance said the European Central Bank (ECB) needs to confront the market with a wall of money and keep buying as many Spanish and Italian bonds as it takes to convince everyone there is no prospect of a Spanish or Italian default.
This is the approach adopted by the US government, which stopped the rot in that country by throwing money at the problem. The government took stakes in Wall Street banks, bought AIG, bought Fannie Mae and Freddie Mac, and nationalised a large part of the US auto industry.
The US government could do this because it has endless funds. It issues bonds and the Federal Reserve buys them. Economics tells us this behaviour will ultimately lead to inflation, but in US eyes that is a problem for another day.
Europe could do the same in theory. Giant US bank Citi estimates the ECB has a €3 trillion war chest to buy bonds with, which even the most pessimistic of observers believe would be enough to convince markets that Italy and Spain will not default.
However, under its own rules the ECB cannot directly buy the bonds of member states. All sorts of remedies have been proposed to get around this rule, but for the time being the ECB is not playing ball.
The reason for that, we understand, is that the ECB is modelled on the German Bundesbank and the policies adopted by it since the end of the second World War, which focus on keeping inflation down. Facilitating the printing of money by governments is about as far away from this goal as it’s possible to be.
It is too simplistic to say the ECB is a prisoner of Germany’s past, but without a doubt few countries understand the danger of inflation better than Germany. The strongest argument against debasing the ECB is not inflation risk but the issue that has bedevilled pretty much every other credible solution to the euro zone debt problem – the lack of fiscal union.
If the US treasury lends to the US government it has reason to believe the government will do its best to pay it back, as both entities pursue a common goal of a peaceful and prosperous US. If the ECB lends to euro area sovereigns or some proxy such as the European Financial Stability Facility, it has no such assurance.
The events of the last week in Greece and Italy would only make you more convinced that domestic imperatives will trump the obligation to repay the ECB in some countries, leaving the better-off countries to cover their liabilities. For better-off countries, read German taxpayers.
The deployment of the ECB balance sheet without some sort of credible fiscal union and governance infrastructure to make sure such does not happen would be an act of folly.
That is not to say it will not happen, as it’s the solution the market wants. It also appears to be the solution the rest of the world wants.
The lukewarm response of the G20 to the current proposal that they should contribute to a special fund that would lend to euro zone sovereigns is eminently understandable.
If you were part of the government of Brazil, would you really see much sense in subscribing to a rescue fund for an entity that has a central bank with €3 trillion balance sheet that it is afraid to deploy for fear of stoking inflation?
From the perspective of such countries, Europe is tying itself up in knots and going round with a begging bowl to avoid using its central bank for one of the prime reasons countries have central banks. There is something of the kid who keeps Matchbox cars in unopened boxes but demands to be allowed play with everyone else’s about this scenario.
Equally, viewed through G20 eyes, Germany’s intransigence over the ECB is hard to accept given the extent to which its economy has benefited from the European project, far more than in other G20 states. Why should Brazilian taxpayers take such risk when the Germans will not?
More than ever there is a certain “all roads lead to Frankfurt” inevitability about the solution to the euro zone debt crisis. Which road we go down to get there remains to be decided, but as things stand it looks as if things will have to escalate to the point where a binary choice faces Germany: debase the ECB or see the euro zone break up as market support for Italy or Spain or France evaporates.