There is one hell of a rumpus going on at the moment, in particular about the recent statements made by the German politician Otto Bernhardt, a leading member of Angela Merkel’s Christian Democrat party, in a Reuters interview last Thursday. There is also a hell of a rumpus going on in the United States about the Geithner Bailout. My point here is simple, one and the same issues are involved in both cases, although in the latter we are talking about banks, while in the former we are talking about entire countries.
Part of the issue is moral hazard. What both the US Treasury and the EU Commission/ECB seem to be doing at the moment is bailing people out without recourse, and this is dangerous at the best of times, but when it simply won’t work (which I’m sure of in Europe, and Krugman estimates in the US) then it almost amounts to recklessness. The core of the present policy seems to have been enunciated by the hapless Otto Bernhardt in his unfortunate Reuters interview:
“There is a plan.” He added: “The finance ministers have agreed the procedures. The core point is: ‘We won’t let anyone go bust’.”
So the message is clear: no one can go bust. What’s more, the cat is out of the bag, the Almunia Syllogism is logically rigorous and well-founded.
Bernhardt said in the Thursday interview that the danger for Germany of not helping would outweigh the cost of helping: “What is the alternative? We would otherwise lose our currency.”
Thus this is no “disinterested” offer of help, the bad countries have the good ones (assuming we can be this simplistic in dividing “good” and “bad”, which I actually doubt we can) by the short and curlies. So, I ask you, is the policy of telling them “don’t worry, we won’t let you go bust” really the best one in these circumstances.
My view is that it isn’t, and since, as Lennie Bruce surely explained to Bob Dylan in that brief taxi ride they enjoyed together, timing is everything in comedy, how fortunate that just this weekend I have an article on these very issues written for the American magazine Foreign Policy. I recommend reading the whole piece (I would, wouldn’t I, I wrote it), but here is the most relevant passage:
As Paul Krugman has pointed out, the EU now badly needs to remedy its institutional deficiencies in order to address its crisis overload problem. Fortunately remedies are available, even if getting Europeâ€™s leaders to talk about them is akin to leading a reluctant father-to-be up to the altar. First, EU (rather than exclusively national) bonds can be created and these will effectively give Europe a fiscal capacity which is to all intent and purpose equivalent to that of the United States Treasury. Second, given the deflation problem, the European Central Bank can now follow the Bank of England, and the National Bank of Switzerland by entering the next tier of quantitative easing, expanding its balance sheet, and starting to buy those nice new crisp EU bonds in the primary market. Quantitative easing, which is simply a generic way of referring to all the recent attempts to boost money supply when interest rates fall near to zero, becomes in this particular case a euphemism for â€œprinting moneyâ€, with the unusual characteristic that this time round inflation is what we are actually looking for. And if we donâ€™t get it, well, as Krugman said in his New York Times Op-ed on Spain this week, we run the risk of ending up with a Europen economy which is depressed and tending towards deflation for years to come.
Thirdly, the rules of the Maastricht treaty should be rewritten to give rapid access to the Eurozone to the highly vulnerable countries of the east. All these countries, given the euro membership condition attached to their EU membership, have been suffering, either directly (in the case of those countries whose currencies are pegged to the euro â€“ the Baltics and Bulgaria) or indirectly (in the case of those countries who have floating currencies, but whose economies are tied through exports to Western Europe â€“ Poland, the Czech Republic, Hungary and Romania) from the â€œgravitationalâ€ consequences of being in such close proximity to the currency union. Having been through the win-win phase of cheap money, housing and construction booms, and large financial inflows to fund growing current account deficits, these economies are now entering the lose-lose one, as funding is withdrawn, their currencies come under pressure, and the current account deficits spiral down to zero as exports, imports and living standards all drop sharply in an external environment which has now become incredibly hostile. These economies should never have had the funding for their exaggerated growth in the first place, and now, given the hard global conditions, they are unable to adjust by boosting exports, since the demand for their products just isnâ€™t there. They need short term protection, and then long term nurturing, and the Eurozone structure is itself the best â€œincubatorâ€ we currently have to hand.
Lastly, Europe badly needs a new pact, a much tougher one than the old Stability and Growth version which emerged from the Maastricht Treaty. What Europe needs is a pact where each government is given clearcut performance objectives, one which has the teeth to enable the Brusselâ€™s based Commission to see through the deep-seated structural reforms that so many of Europeâ€™s economies so badly need.
The most important thing to realize is that the arrival of deflation is not only a threat, it is also an opportunity. Having the power (nay the necessity) to print money should give Europe’s central administration one hell of a lot of clout should it need to use it, and it will. As Economy and Finance Commissioner JoaquÃn Almunia said earlier this month, “You would have to be crazy to want to leave the eurozone right now.â€ Precisely the existence of this fear about what would happen to any economy which was forced out of the Eurozone should serve as a pretty persuasive stick with which to accompany that attractive financial carrot. Assuming, of course, Europeâ€™s leaders understand that, in this case at least, sparing the rod would only amount to spoiling not only the child, but all the brothers and sisters and aunts and uncles, too.
So while the first argument in favor of EU bonds may be an entirely pragmatic one, namely that it doesnâ€™t make sense for subsidiary components of EU Inc. to be paying more to borrow money when the credit guarantee of the parent entity can get it for them far cheaper, the longer term argument is that the ability to issue such bonds may well enable the EU Commission to become something it has long dreamed of becoming — an internal credit rating agency for EU national debt. The EU can talk people in with the persuasive power of cheaper finance and even pooled resources, but it could equally (if it has the will to do so) use precisely this leverage to cajole reluctant parties to live up to their performance objectives, because if not they could have access to this particular financial channel denied, and need to seek more of their financing through issuing their own national bonds, with all that this would mean in terms of the consequent deterioration in their bond spreads. That is, a negative report under these circumstances from the EU Commission could have just the same negative impact, as a â€œcredit watch negative outlookâ€ warning from S&Ps or Moodyâ€™s does now. All that is needed is the will.
So let’s run through this again. The EU/ECB is simply saying “we won’t let you go bust”.
Edward Hugh is saying, we won’t let you go bust, since we are going to help you by funding you (in part) with EU Bonds. But if you want to have access to those bonds you are going to do as we say.
Which approach sounds more effective and likely to succeed to you?