Europe is heading into yet another moment of truth this week, with a Merkozy summit and a new plan, an ECB meeting and likely interest rate cut, and a full EU summit starting Friday.
The game is afoot, with titanic collisions between proverbial unstoppable forces and immovable objects:
- The ECB vs. market consensus. Sovereign rates have soared to levels that imply defaults and debt-deflation death spirals. Banks are skittish about lending to each other. Funds on deposit at the ECB by strong banks have soared, and less liquid banks’ emergency borrowings from the ECB are at record levels. Rumors fly about the viability of major financial institutions, and there is open speculation about whether major countries will remain in the Euro. The market consensus is clear: imminent financial catastrophe can be averted by only one thing, quantitative easing by the ECB and large scale purchases of sovereign debt. And yet, this is the what the ECB was pledged from birth to never do: compromise independent monetary policy to fiscal needs of member states, fund deficit spending and monetize sovereign debt.
- Fiscal union vs. sovereignty. Trichet, single-mindedly defending the ECB’s independence, credibility, and anti-inflation mandate, tightened policy as recently as April, and claimed his record was ‘impeccable’. But the captain of the Titanic undoubtedly provided an impeccable ride to the site of the iceberg. There is a fine line between a parent’s tough love, the abuse of an evil stepmother. More recently, ECB resolve on bond buying and Eurobonds has weakened considerably as market conditions have worsened. It seems that the ECB is willing to administer stronger medicine, if there are strong assurances the patient will not become an addict. The general idea would be to print money, lend it to the IMF, which would lend on to the countries in increasingly dire need and impose the necessary conditions (since it’s bad form for Frankfurt to tell Luigi he has to lose his pension). Longer term, fiscal prudence would be imposed through measures like mandatory sinking funds and debt brakes to reduce debt to manageable levels, and EC-level veto on national budgets. There is a strong argument that opening the floodgates of quantitative easing, and imposing credible fiscal tightening and debt reduction would be the best possible policy. But politically, to ask politicians and voters to give up national sovereignty and the ability to distribute and receive pork is a practically impossible pill to swallow.
- Austerity vs. electability. The ECB holds all the cards. If the non-German politicians wish to avoid financial and economic crisis, they are well advised to do whatever the ECB and Merkel demand. But they are damned either way. If they give in, they face years of harsh austerity, and the surrender of a large degree of economic sovereignty. Electoral defeat seems the practically inevitable result. Even if everyone agrees, it’s not clear the ECB is willing to give the blanket guarantee and ‘shock and awe’ which might be the only thing to stem the crisis. The economic environment is so bad (20% unemployment in Spain), that whoever is elected might well decide to default and leave the Euro, unleashing the chaos everyone is doing everything to avoid.
I’d like to be optimistic, but an awful lot has to go right. Critically, growth has to resume to make the debt and politics manageable. It’s hard to see how that will happen with tight fiscal policy and a credit crunch. And in the long run, without harmonization of economic conditions, labor mobility, fiscal transfers to areas harmed by EU policies from areas that benefit, and a lender of last resort, an insurmountable crisis seems inevitable.
Separately, the talking point has emerged that the because the IMF is involved, the US is bailing out Europe. Let’s try to break it down.
The IMF is the world’s biggest credit union. The member nations deposit money (quotas). They get votes in proportion to how much they deposit. Then, when one of them runs into a balance of payments crisis, they can tap the IMF for a loan, if they agree to the terms of a stabilization program. (Which can be harsh, but no one is forcing them to take the loan.)
The IMF doesn’t have the resources to bail out Europe. Only the ECB does, by virtue of being able to print as many Euros as necessary. So the ECB is going to tell the IMF ‘credit union’, we’ll deposit Euros, if you lend them to
If one may be permitted a bit of colorful imagery, the ECB and Germany are using the IMF as a prophylactic to screw the periphery. It’s the IMF’s core competency, monitoring austerity programs. The ECB thinks its core competency is the immaculate conception of ‘impeccable’ monetary policy. It certainly doesn’t want to be seen as determining fiscal policy, or to have its fingerprints on the resulting austerity measures. It’s not reasonable or feasible for the IMF to put up the money or bear the credit risk, so they won’t.
Since the US currently has a bit less than 20% of the overall IMF quota, and stands behind the IMF, and there is talk of the Fed providing token additional funds and moral support, some might say the US is helping bail out Europe. But it’s a pretty thin argument. It doesn’t seem likely significant US taxpayer funds will be at risk. The same is true for the Fed swap lines that allow the ECB to lend dollars. To the extent these operations are unsterilized they are additional QE.
The best way to view this talking point is in the context of pressure from Rick Perry and others to prevent additional action by the Fed to help the economy. It’s a red-meat talking point, and fodder for those who would accuse the GOP of wanting European and US economic growth to suffer, in order to advance their electoral prospects.