Friday, 18 November 2011

Forget about it; the ECB isn't going to bailout the Eurozone

Yesterday was rough for the eurozone. Government bond yields rose sharply. Countries that thought they were immune from the crisis - France, Austria and the Netherlands - are now seeing their borrowing costs rise. No one is now safe from the contagion.

There is "almost unanimous agreement" that only the ECB can save the eurozone. The rescue plan is disarmingly simple. The central bank should bail out eurozone governments directly through direct purchases of bonds.

There is only two difficulties with the plan. First, that "almost unanimous agreement" does not extend to Germany or the ECB itself. Second, the ECB is legally prevented from providing credit to member state governments, the EC or any other EU institution.  So, an ECB-centered  bailout isn't happening, and there is no other credible bailout plan on the table. So where does the Eurozone go from here?

Broadly speaking, there are two answers to this question. The first tries to re-establish the ECB bailout plan by designing an elaborate financially engineered scam whereby the ECB provides credit indirectly to illiquid governments. Almost weekly, these plans emerge. They stir up excitement in financial markets and policy circles.  Then an official from the German finance ministry or the ECB describe the plan as either unworkable or illegal and the excitement dies down.

The second answer is austerity. Illiquid governments like Italy and Spain have to balance their books. They have to rein in expenditures and raise more taxes. If austerity results in a recession that reduces tax revenues, and increases the fiscal deficit, then another round of cuts and tax hikes are required. Governments just have to keep cutting and taxing until they can convince bond markets that their fiscal position is sustainable. Greece, Ireland, and Portugal have all gone down that road. So far, none of these countries have been able to successfully return to the bond market.

Many Eurozone policy makers balk at the idea of supervising brutal cuts in living standards. However, the bond market has no time for squeamish polititicans. The choice is cut the fiscal deficit or face being shut out of capital markets. Slowly, European politicians are getting the message.

But what of Germany and the ECB? Wouldn't things be so much easier if they quietly acquiesed and allowed the ECB to fund eurozone fiscal deficits? Once the central bank begins printing money to keep those Southern European wastrels afloat, when will it stop? Will it be any easier to adjust after two years of funding Italian public sector wages than it is today? Once the ECB starts bailing out Southern Europe, the incentive to cut deficits will vanish. Germany knows that a bailout will only prolong the crisis. The ECB knows it too.


davidb said...

Its a realtime lesson in the effects of maintaining the gold standard in the 1920's. No history lesson I have read quite puts over the whole gory mess as watching the slow Euro car crash. And yet our own currency has risen only 10% from its nadir in price against the Euro. We must be in some mess too.

Stevie b. said...

"so where does the Eurozone go from here? Broadly speaking, there are two answers to this question"

Surely there is (and in this case may well be) -The Third Way-? The eurozone will fracture and the missing but vital ingredient will come into play - namely devaluation. Surely "they" will find some devious but necessary way of simultaneously devaluing existing debt by re-denominating it into the local currency. With a fair dose of austerity at the same time, we'd all be off to the races again for at least one more go round the cyclical track.

Anonymous said...

Germany is dominating Europe

Electro-Kevin said...

Austerity won't work in the illiquid countries.

Free movement of labour across the EU will see mass migration of disaffected workers from impoverished countries.

Britain is about to get a whole lot cosier and there's nothing can be done about it.

Cameron needs to renegotiate our relationship with the EU sharpish. Only he won't. He's an utter twunt.

Now we shall see the true mettle of the Tory back benchers. If they have any then they ought to cause the coalition to disintegrate in the near future.

Stevie b. said...

The moral seems to me to be that the euro is the new gold standard and half of Europe needs to decouple from it to survive.

Mad Numismatist said...

The ECB is the ultimate goal. It is a quantum leap forward in a one world government/ currency. Independent of a sovereign treasury, privately owned and no democratic oversight. The ECB is the power in Europe, and intentionally so.

It is a consensus forum of appointed stooges. Draghi is just the latest. TPTB will do everything, including war, to keep the dream alive. No Euro no ECB. Sadly the Germans will just follow along with whatever they are told, and by all accounts it will be cheaper to keep it than lose for them.

Anonymous said...


Anonymous said...

The Powers That Be

SEO Specialist Philippines said...
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RenterGirl said...

Alice - you've been spammed by those hugely irritating SEO spammers. Pointless, usually badly spelled comments irrelevant to the discussion. they drive me CRAZY!

Alice Cook said...

Renter Girl,

Whenever I find them, I zap them