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Jean-Claude Trichet: this is the most severe economic situation that Europe has faced “since WWII, possibly even WWI” |
Last month the eurozone sovereign debt crisis reached a stress point that threatened to blow the euro currency system apart. Although I don’t think this will happen, the euro suffered a serious credibility deficit. European leaders rushed to plug the gap in the sovereign debt dykes that had been breached by bond investors. They came up with an emergency financing package designed to convince markets that they cannot win in forcing any eurozone state into defaulting on its debt.
Initially, markets were wowed by the size of the package – but not for long. After all, the EMU leaders have merely heaped up more debt and applied it to a problem that is about too much debt. The solution to a hangover is not more alcohol.
The other shock was the decision to involve the independent European Central Bank in the financing package. The ECB has now started to buy the potentially toxic sovereign bonds of Greece, Portugal and the others from Europe’s banks. In this way, the ECB is now taking on the risk that these governments will default on their debt.
This is an earthquake that marks a definitive divorce of ECB policy from all Bundesbank best practice. The ECB is directly intervening in sovereign bond markets to distort the price of risk to finance the budget deficits of profligate countries.
Germany reluctantly accepted this emergency package. However, the Germans will insist that any funds handed out to heavily indebted eurozone states must be on the basis of conditions agreed with the IMF and the European Commission. Europe’s fiscal war is only just beginning.
Political resistance
And there is going to be a lot of political resistance to measures that have been jumbled together by an elite at a weekend confab without reference to their electorates. There is a chance that the whole thing will become unstuck politically and cannot be delivered.
In Germany, chancellor Angela Merkel’s party was heavily defeated in a regional election because of her inept handling of this crisis and has now lost her upper-house majority in the federal parliament. As a result, the ruling coalition is pretty well stymied on its political programme.
Above all, this package will not end the crisis because it involves the creation of more sovereign debt to solve the problem of there being too much already. It’s the story that I have outlined for the whole of the OECD, including the high-deficit, high-debt UK, US and Japan, in my book Sovereign DisCredit! The world is facing a sovereign debt crisis that will squeeze economic growth and possibly deliver a series of debt default events down the road. The EMU crisis is a harbinger for the future elsewhere.
Squirm and squeal
But what won’t happen is that Greece and other EMU states will leave the eurozone and the euro will break up. Greece will suffer, it will squirm, it will squeal and it might fail to do what is demanded of it. But it will not leave or be kicked out of Europe – as long as it does not fall into the hands of a populist government.
The bottom line is that the rest of Europe can afford to pillory Greece partly because the country has few remaining friends on the continent and partly because it is small enough to be made an example of. Germany hopes that being hard on Greece will send a strong message to all other EMU nations to reduce their ballooning budget deficits.
Indeed, the way that Germany is applying pressure on Greece shows that Germany remains determined to run a unified currency that is stable and based on rigorous economic criteria. Under German pressure, there is the slim possibility that over the next year or so the profligate states of the eurozone could meet their fiscal targets without restructuring their debts. More likely, there will eventually have to be some debt restructuring.
ECB president Jean-Claude Trichet has claimed this is the most severe economic situation that Europe has faced “since WWII, possibly even WWI” (so demoting the Great Depression, Weimar Republic hyperinflation and the rise of fascism, as well as the collapse of communism in eastern Europe).
But, as I have argued before, the monetary union would only collapse if and when Germany itself became tired of the arrangement, and there is no sign of that happening yet.
David Roche is president of Independent Strategy Ltd, a London-based research firm. www.instrategy.com
