Il Sole 24 Ore just published an editorial I wrote with Jean-Luc Gaffard, on the structural problems facing the EU. Here is an English (slightly longer and different) version of the piece:
It is hard not to rejoice at the ECB announcement that it would buy, if necessary, an unlimited amount of government bonds. The Outright Monetary Transactions (OMT) program is meant to protect from speculation countries that would otherwise have no choice but to abandon the euro zone, causing the implosion of the single currency. As had to be expected, the mere announcement that the ECB was willing to act (at least partially) as a lender of last resort calmed speculation and spreads came down to more reasonable levels.
I have read an interesting article by Wolfgang Münchau, on the Financial Times. To summarize, Münchau argues that because of politician’s complacency, there is a chance that the new OMTs program launched by the ECB will never be used, and hence prove ineffective in boosting the economy. He therefore argues that the ECB should have done like the Fed, and announce an unconditional bond purchase program (private and public alike).
The piece is interesting because Münchau is at the same time right, and off the target. It is worth trying to clarify.
There was a lot of noise, yesterday, about the main central banks’ decision to coordinate in maximizing liquidity provision (in dollars) to households and firms. An excellent and clear explanation of what they exactly did can be found here.
Are we effectively at a turning point? I am afraid not, for essentially two reasons:
- The first is that, after an initial moment of euphoria, markets may realize what really happened, i.e. that central banks are preparing for a major Lehman-like event: If the euro breaks down, and if investors flee from it, central banks are ready to act to avoid contagion. This is reassuring, but it also informs us that the main monetary authorities of the planet are seriously considering the possibility of such an event occurring.
- Second, this move, per se, does nothing to address the main source of the problem: the lack of proper Eurozone governance, and the unwillingness of the ECB to act as a lender/buyer of last resort. Major changes on these issues would be a turning point, reducing the risk of a euro crisis, and hence making liquidity in dollars unnecessary.
A safe bet: Financial market euphoria will be short-lived.
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!“
For observers of EMU woes, it came as no surprise that Wednesday’s summit in Brussels ended in a low-key compromise that leaves the eurozone fragility untouched.
In part this is due to the decision making process in the EU, intrinsically incapable of reaching quick and bold decisions. But there are more substantial reasons that lie in the interpretation of the crisis, the “blame game”; a blame game that has no particular interest, were it not that understanding what went wrong should constitute a guide for designing a durable and effective solution.