Can a real central bank save Europe?
Why is it that the U.S., Britain and Japan, despite their huge debts and other economic problems, have not succumbed to the financial crises that are threatening national bankruptcy for Greece, Spain and Italy – and perhaps soon for France?
After all, even the strongest British and American banks, such as HSBC and JPMorgan Chase, have now admitted that they were as accident-prone as their continental rivals. Borrowing by the U.S., British and Japanese governments is well above European levels relative to the size of the economy. These governments are not even considering fiscal consolidation as ambitious as the 3 percent deficit targets now being written into national constitutions across most of Europe – and Britain has missed by a wide margin the much less demanding targets David Cameron set himself in 2010.
Given that financial markets are supposed to be dispassionate arbiters of economic management, why are they punishing Mediterranean countries with cripplingly high interest rates, while the British, U.S. and Japanese governments are left free to borrow without any apparent limits at almost zero cost?
In the U.S., the standard answer is that the dollar enjoys “reserve currency status,” since it is the main currency of global trade and investment. But this explanation is clearly wrong, or at least irrelevant, as evidenced by the equally low interest rates in Japan and Britain, without this supposed ”status.” Moreover, the euro has been increasingly used as a reserve currency, but this has been no help to Greece, Italy or Spain.
Which brings us to the less flattering Eurocentric explanations of the unequal treatment meted out by investors to what they often describe as “the Club Med” countries. These range from philosophical statements whose precise meaning is never clear – such as Europe’s lack of “political solidarity” or “economic convergence” – to claims verging on racism that prudent investors would never lend money to these countries because their national characters are rotten to the core: The Greeks are all corrupt, the Spaniards inefficient and the Italians lazy. As for the French, well maybe they are oversexed or rude – or just French.
Such impressionistic explanations of market behavior are not just insulting and morally repugnant (imagine if such national stereotypes, which appear constantly in the German and British media, were applied to Jews, Africans or Muslims). They are also factually wrong – for example, Italians on average work 27 percent longer than German workers (1,773 hours each year versus 1,390, according to the U.S. Bureau of Labor Statistics, and Italy’s long-term pension liabilities are smaller than Germany’s (relative to GDP), according to the IMF.
Worst of all, however, the racist stereotyping that passes for rational analysis of the European crisis deflects attention from a genuine difference between Europe and the rest of the world that perfectly explains the markets’ behavior. There is one simple difference between all the European victims of financial crisis and the lucky countries that are given a free pass by investors, despite even bigger deficits and worse banking crises. The countries with immunity control their own currencies and central banks. They thus have the power to print money, which they use to the full. By the principle of Occam’s razor, this one simple explanation should be viewed as the main reason for Europe’s present crisis.
The ability to print money, officially known as quantitative easing (QE), has allowed the U.S., British and Japanese governments to run whatever deficits they wanted and to offer their banks unlimited support without suffering the sky-high interest rates that are now driving the Club Med countries toward bankruptcy. Instead of raising money from private investors, these governments finance their public spending and deficits by borrowing from their own central banks. This means that the U.S., British and Japanese governments are actually much more solvent than their huge deficits suggest, because much of their debt does not really exist. They are an accounting fiction – an IOU from one branch of government, the treasury, to another, the central bank. The Bank of England, for example, is lending £375 billion to the British government in 2009-12, out of a total planned deficit of around £450 billion. The Fed’s $3 trillion balance sheet effectively reduces the U.S. government’s total debt by 20 percent, from $16 trillion to $13 trillion.
Of course using printed money to finance government deficits cannot permanently solve structural economic problems such as poor education, crumbling transport infrastructure or unaffordable pension commitments – and in some circumstances financing of deficits by central banks can be extremely dangerous, generating rapid inflation. But the world today is not threatened by inflation and overspending, as it was in the 1970s and 1980s. Instead the danger is generally thought to be deflation caused by inadequate investment, weak consumer spending and falling wages, as in the 1930s. Thus a policy that would rightly have been denounced as counterproductive and irresponsible 40 years ago, is now both necessary and prudent – as demonstrated by the willingness of every major central bank in the world, including the ultimate guardians of monetary stability at the Swiss National Bank, to undertake QE. The only important exception has been the European Central Bank.
On Wednesday this week the IMF issued a report publicly urging the ECB to implement a “sizeable” program of quantitative easing. If the ECB did this, the euro crisis would soon be resolved. If, on the other hand, Europe will not allow its central bank to play by the same rules as the Fed and the Bank of England, then all efforts to save the euro are doomed to failure.
PHOTO: A photographer takes a picture of the construction site of the new headquarters of the European Central Bank (ECB), in Frankfurt July 16, 2012. REUTERS/Kai Pfaffenbach