Fear of contagion is palpable among anxious central bankers

EUROPEAN DIARY:There is a sense that the fate of Greece has grave implications for everyone – in the euro zone and beyond

CENTRAL BANKERS are a bit like nuclear scientists and military generals: if you find yourself being forced to listen to them day after day, the news cannot be good.

In ordinary times, a speech by a central banker should provide the perfect opportunity for a snooze. The same goes for soldiers, unless there’s a war, and for nuclear types. Trouble must be afoot if you instinctively perk up when someone mentions the words “fuel” and “rod” in quick succession.

So there they go in Europe, slouching into summer as the debt mess worsens. Some time today we will know whether Greek MPs pass a €78 billion austerity and privatisation plan. The expectation is that they will, just about, but it’s not going to silence the central bankers.

Every day they’re out, their anxiety endless, their demands for resolute political action relentless.

These are the people who see the gory inner workings of the financial system, the daily ebb and flow of cash and confidence. Both of these commodities are far too scarce.

While the Greek crisis transfixes the European authorities, the big fear is that the rot will spread. We already know what that means in the Irish context, as notional borrowing costs rocket and the long road back to the market grows longer.

But it’s more than that. Listen to a central banker – any central banker – and the dread of contagion extending to Spain, Italy and other heavily-indebted euro countries is palpable.

So too is fear that the tidal wave could sweep beyond the boundaries of the euro zone.

European Central Bank president Jean-Claude Trichet says red warning lights are flashing in the single currency area. He sees grave dangers in the “interplay” between frail public finances in the weakest euro-zone countries and the banking system, with potential contagion effects in Europe and beyond.

Nothing particularly new there, although it amplifies the sense that the fate of Greece has grave implications for everyone. All eyes are on Athens, all systems are on high alert.

A couple of weeks ago, outgoing Dutch central bank chief Nout Wellink called for a doubling of the euro-zone rescue fund to €1.5 trillion from €750 billion. That’s a political impossibility right now, but Wellink still saw the need to say it loud and clear.

In light of confusion over the recruitment of private creditors to help a second Greek bailout, he said the expansion was required to deal with contagion risk. “If you’re at risk of falling through the ice, then you need to have a very big safety net,” he said.

Similar concern is to be heard outside the euro zone. Bank of England governor Mervyn King says a road map is still required to show markets a way out of the Greek cul-de-sac. Sovereign and banking strains represent the most material and immediate threat to the British economy, he warns.

Likewise, US Federal Reserve chairman Ben Bernanke sees the threat of “quite significant” spillover if the Greet rescue effort falls flat.

“If there were a failure to resolve that situation, it would pose threats to the European financial system, the global financial system and to European political unity I would conjecture as well,” he said.

The bankers’ message is clear: political leaders need to do a lot more to tame the beast. Unlike central bankers, however, politicians must contend with voters who tend to punish actions they do not like. In that sense the chasm between the two is vast.

At one level, the crisis has seen central bankers take unprecedented action to prop up the financial system by supporting banks and sovereign bond markets. In this way the concept of the lender of last resort has been stretched to its very limits.

At another level, central bankers have also emerged as the final line of defence against any Greek default.

Their argument, questioned by an increasing number of market participants, is that any default would cause a lot more problems than it solves. For all German leaders twist and turn, it is an argument they are loath to test.

Important here too is that any such development would impose big losses on the ECB’s balance sheet, while at the same time creating an increased need for yet more market interventions.

Last Friday in Brussels, EU leaders chose Italian central bank governor Mario Draghi to succeed Trichet at the helm of the ECB. Little change is expected in core ECB dogma, although he will have to unwind the bank’s extraordinary entanglements in the banking and debt markets.

In the course of his eight-year mandate, Draghi may well outlast many of the leaders who appointed him. For years to come we will hang on his every word.