It had to be expected. Yesterday Germany only placed 3.9bn euros worth of 10-year bonds, from 6bn euros on offer, and the yields started climbing. This means that we are quickly entering into a new phase of the euro crisis.
I think it is useful to list, and assess, the main arguments advanced against an enhanced role of the ECB as a lender/buyer of last resort. I can think of four of them: credibility, inflation, irrelevance, ineffectiveness.
There are two interesting developments in the eurozone crisis.
- The first is that there seems to be no discrimination coming from financial markets anymore. The French (and Dutch, and Belgian, and counting…) spreads are dangerously increasing, not for objective reasons, but rather because France (and then Belgium, and the Netherlands, and counting…) is perceived as the next country in line after Italy. It is clear that the process will not stop, and that today the only investment that is considered safe is German bunds.
- The second development is that besides the German government, the Bundesbank president, and of course the ECB, there is increasing consensus that only a radical shift in monetary policy can stop contagion, building a firewall around eurozone sovereign debt. It is impossible to have well functioning bonds markets with 17 governments de facto borrowing in foreign currencies, and without a lender of last resort.
The two developments are of course related. It becomes increasingly clear that national government, independently of their past wrongdoings or virtuous behavior, are less and less responsible for speculative attacks, that seem to be fueled by the perceived flaws in the EMU governance design: countries with very limited fiscal space and even more limited fiscal pooling, borrowing in a foreign currency without a Lender of last resort umbrella, and experiencing increasing external imbalances.
As somebody would have said some time ago, “it’s the eurozone, stupid!“
Last week, among the many bad news for the eurozone, one was in my opinion not sufficiently commented: in September industrial orders in Germany dropped considerably. What is particularly interesting is the source of this drop:
Both foreign and domestic orders declined this time. Orders from outside Germany were dragged 5.4 lower overall by a 12.1 percent plunge in orders from elsewhere in the 17-nation eurozone.
This news is hardly surprising. The latest forecasts from the European Commission confirm what seemed obvious: the wave of fiscal consolidation, largely dependent on the intransigent stance of Germany, is killing European growth. And not too much help can be expected from the United States.
This time it looks like Germany will not be able to export its way out of the crisis, and will have to find growth domestically. If only they resolved to do so, it would be great news for the rest of us as well…
There is no need to write a post on the latest developments in Italy and in the eurozone. Paul Krugman says better than I could, how close we are to Armageddon.
There is only one very minor point of dissent, that for once makes me less pessimist than he is. I give more importance to the Italian internal factors than he does. If a solution is found to the current political turmoil, there may be a truce in the speculative attacks, and the spreads may go down to more manageable levels.
It remains true that without a rapid u-turn of the ECB, speculation will not be defused.
Yesterday I gave a short interview (in French) on the crisis. In particular, my take on the Italian crisis is that the fundamentals are not dramatic, and certainly not worse than they were before the summer. The new element is the increasing political weakness of the Italian government. The absence of political leadership leaves the path open to speculation. Tito Boeri links the spreads to political mismanagement. Without going that far, it is plain that Italy has a political problem far bigger than an economic one.
The EU situation is the same, on a bigger scale. There is a striking difference with the United States where the political system, even in a situation of divided government and economic crisis, can stand in front of speculation. In Europe, the political void leaves the field wide open for market primacy over governments.
In short, we argue that (unfortunately) it will not radically change matters in the EU. The precedent of the London G20 meeting in 2009 is not encouraging. Too many promises ended up being written on the sand…
We also argue that the only possible long term fix for the EMU woes is a radical rethinking of its economic governance, that puts back at the center of the stage discretionary policies.
Finally, out of the meeting should emerge a firm commitment (followed by acts) of the G20 to fight the resurgence of protectionism.
An English version of our piece should follow soon.
Not surprisingly, the deal reached last week failed to put the EMU economies back on track. I have always looked with suspicion, if not with outright fear, to policy agendas dictated by financial markets. But the fact that a simple attempt by the Greek Prime Minister to involve his fellow citizens in crucial decisions is creating a panic attack, shows how fragile the agreement was. With André Grjebine I wrote a piece for the French daily Liberation last week, in which we argued that all the crucial weaknesses of the Eurozone were not addressed.
- Address current account imbalances symmetrically, along the lines already outlined by Keynes before Bretton Woods.
- Focus more on quality of public spending, and not on quantitative targets. We mention the golden rule in its original meaning, i.e. the exclusion of public investment from numerical deficit targets. A study (working paper here) I made with some colleagues a while ago hinted that it worked for the UK.
- Finally, we insisted on debt monetization by the ECB, the only possible strategy to defuse speculation against sovereign debt of a currency union.