Can a real central bank save Europe?

July 19, 2012

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


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

The banking systems is a form of a tiered society and the current plans to support them are adding more clout and special privelages for this class of corporate entity.

Your suggestion for a real central bank will even more so create an elite corporation who controls world economies and will be influenced and directed by the biggest financial players – large mega corporate players outside of any governments control. Basically governments will have no teeth anymore to fight policies they dictate.

What has happened, what you are suggesting and what is coming into play pretty well destroys any form of individual country self direction and falls in to the hands of global corporate entities to further manipulate and drive low cost production at the quality of life expense of many for the benefit of a select few.

We are moving away from capitalism to a new form of feudalism on a grand scale.

Posted by Butch_from_PA | Report as abusive

I hold a Bachelor of Science Degree in Economics and for the life of me I cannot understand how it is that repeated central bank easing is going to solve problems created by incompetent lending practices.

It seems to me that limited QE had merit but the US has made the same mistake as the Bank of Japan, the Federal Reserve has carried QE too far. We had a great time in the eighties and especially the nineties but the good times were based on an economic illusion of easy money. Too easy. One of the fundamentals learned by first and second year economic majors was linear regression. We used calculus to prove the theories but for the layman the concept was fairly simple……

Sooner or later things have to “even out”.

It absolutely terrifies me that in spite of the three to five trillion dollars (depending on what data set you’re looking at) in stimulus, we in the U.S are still barely keeping our heads above water. Based on everything I’ve ever learned our economy should be great and inflation should be a huge problem. It’s not and it isn’t and therein lies the symptom of the severity of our problems.

Posted by Missinginaction | Report as abusive

The problem with Club Med isn’t blind prejudice or some nebulus political analysis, it is simple economics. The euro periphery consumes more than it produces. Its governments spend more than they collect in revenues. The Greeks aren’t necessarily more corrupt, but they are consumate tax evaders which compounds their economic difficulties. The Germans fear an undermining of the currency if the eurozone resorts to massive quantitative easing which is why austerity has been imposed on the weaker euro centric economies.

Clearly, a day of reconning is approaching, not just in Europe, but for the entire world economy. The evening out process is likely to be long and painful. For better or worse, most of us will be around to witness it.

Posted by gordo53 | Report as abusive

As usual from this author- complete BS. “Money printing” cannot be an explanation for the differences in perceptions since it implies market irrationality, namely, that banks care about a haircut when a country defaults but do not care if the same haircut is applied through inflation. No, the real explanation is the “reserve currency” explanation, albeit a historical one. The British pound and US dollar are/have been dominating reserve currencies, dollar now, the pound in past. Since there is no anchor in the system like the gold standard, this status has lead to abuse of the system when costs are shifted abroad (who does not like cheap Chinese goods?) and, as a byproduct, huge and politically influential financial sector. As a result, governments of those countries and “markets” are essentially the same thing. Whether Wall Street controls Capitol Hill or vice versa does not matter but they are closely wired. Defaulting on the US debt would mean to lose confidence in yourself. Which is unlikely. That is so called “flight to safety”, you simply take your printed money home to a place where you control 100% everything.

Posted by tk2 | Report as abusive

This article is effectively saying that we should protect priveleged failure via more money printing.

In addition if one wants to carry on with Japan like policies that the UK and the USA are following then we should expect Japan like outcomes i.e.
(i) Huge ongoing government deficits and build up
of government debt
(ii) An economy that has stagnated for 20 years
(iii) Propping up zombie banks with low interest rates, who in turn prop up zombie companies/entities on extend and pretend schemes. These zombie banks/companies kill the real economy – not allowing their failure perpetuates excess capacity, sucks pricing power and profitability from viable competitors and prevents the system from cleaning itself out.
(iv) A reduction of 70% plus in stock market.

Europe has two keys issues that need to be fixed

(i) An undercapitalised/overleveraged banking system existing on a sliver of equity who are not in a position to take their losses and are thus doing everything in their power to socialise these losses onto the backs of taxpayers (if required via the ECB/ESM).

This socialisation is already happening, in part, via subsidized low interest rates, government guarantees of bank debt, ECB financing of banks unable to access public markets, transfers of bad bank assets onto taxpayer backed vehicles and bailout of sovereigns to date via the ESFS/ESM and the ECB.

However the banks want this socialisation to be expanded so that they don’t have to take potential losses on Spanish or Italian sovereign debt. They are now screaming for either the ECB to buy these debts from them, for these debts to be mutualised onto all Eurozone taxpayers via Eurobonds or for the ESM to get a banking licence (so that it can be levered up via the ECB) to buy these sovereign debts – all of which result in increasing exposure for taxpayers.

(ii) Peripheral European governments who have let public sector expenditure expand dramatically over the last 10 years especially in relation to public sector salaries and pensions.

Trying to solve this mess via more ECB money printing and further socialisation of debt onto to the backs of taxpayers is not a long term viable solution. Two key things need to happen
1. Banks needs to be assessed based on a tri-age system, i.e. those (a) likely to die and who are not viable in the long term, (b) those who could survive with proper treatment but would die otherwise and are viable in the longer term, (c) those with less serious wounds but who need some care.

(a) Those not viable in the longer term and insolvent should be wound down (as in any
insolvency) with losses being borne based on normal principles of priority of creditors.
(b) Those who are likely to be viable in the long term but have an immediate solvency issue
need to go through a FDIC/Iceland like process where assets are seized and divided into a
good and bad bank. The good bank assets can be either onsold or recapitalised (via
restructuring of existing creditors if necessary) with the remaining bad bank being wound
down and any proceeds from this process plus proceeds from the good bank sale used to
pay off creditors in existence at time of seizure.

(c) These banks need to be recapitalised – this can be done via restrictions on cash
dividends, share buybacks and cash bonuses but may also need recapitalisation
temporarily via Governments.

2. Governments need to get their spending under control which may mean some painful reductions in salaries and pensions.

If government have to default or restructure their debt then so be it. One way to do this (other than via a hard default) in a controlled manner without imposing costs on taxpayers would to transfer a certain portion of their debt to a central fund and for repayments to be funded via a financial transaction tax on all share, bond, derivative, swap, forex transactions in the Eurozone. Let’s say €1.6 Trillion of Sovereign debt was transferred to such a fund (€1.0 trillion Italy, €0.3 trillion Spain and €0.3 trillion Ireland, Portugal and Greece) this could be repaid over 20 years at circa €115bn a year assuming interest rate of 4%.

This €115bn repayment per annum would be a financial transaction tax equivalent to circa 0.9% of Eurozone GDP (assuming Eurozone GDP of circa 12 trillion per annum) – a small price for the financial industry to pay to get themselves out of the mess they in large part created.

Posted by Maunsell | Report as abusive

Small states have a great portion of GDP in trade. The ones in question simply do not export enough to support their imports. They need to grow export industry even if they have exit the EU to do it.

Some ways to do it are export subsidies, tax on non-export industries and non-export industry investments. Loans to firms expanding exports and cutting prices.

Posted by Samuel-1-Reich | Report as abusive

The difference is that the USA, Japan , and the UK are single countries, whereas the EU is not. Deficit spending in the USA is done by the Federal Government. If the ECB funded the deficits of Greece, Spain, Ireland, etc…, that would be the equivalent of our own Fed buying the debt of California, Illinois, and New Jersey. Even with his vast powers, Bernanke never suggested that he has the legal right to buy Munis. If the Fed monetized CA debt, the other States would be screaming bloody murder. Subsidizing the budgets of some states more than others is what politics is for, and central banks are not competent to do this. That role is for Parliaments.

Posted by Andrewp111 | Report as abusive

[…] Can a real central bank save Europe? | Anatole Kaletsky […]

Posted by The Long-Term Argument for Avoiding Long-Term Arguments | AgoraNews | Report as abusive

The ECB has abdicated its responsibility to insure an orderly financial system, actually by the ECB own admission their monetary policy is not being transmitted (Christian Noyer – July 16th) yet I don’t see them do anything about except talk. It is comical that Draghi talks this Saturday about a stable Euro, talk from an institution that has no credibility is worthless, only real action showing that they really stand behind the Euro matters; the funny thing is that they claim to be trying to safeguard the value of the currency by not printing it, yet the value of the currency is being destroyed due to lack of faith in its viability, a far worse demise than QE.

Posted by Nawaralsaadi3 | Report as abusive

Small nations have a greater proportion of GDP in trade than the USA. The weak ones in Europe import much more than they export and invested in temporally raising local real estate prices. They need to invest in export industries and tax other investment by locals and other things along that line even if kicks them out of the EU.

The problem is not financial manipulation it lack of Export industries and no one telling the voters that. Also things like corruption make running large enterprises hard.

Te USA is larger so it will take more time but we appear to be in same boat.

Posted by Samrch | Report as abusive

As long as the weak nations import more than they export. They will have financial problems. Manipulation of debt will not hit the underling problem that they do not invest in local export industries.

Posted by Samrch | Report as abusive

[…] Reuters UK (blog) […]

Posted by The Secret Tool Draghi Uses to Run Europe – Forbes | Financial News | Report as abusive

[…] Reuters UK […]

Posted by Stocks fall as Europe fears surge – Los Angeles Times | Headline News Network | Report as abusive

Maybe it is time to repay the debt ?

Posted by whyknot | Report as abusive

I don’t really understand why having central bank allowing governments to spend as much money as they want without any control or contingency is considered to be the adequate long term solution especially when stock of debt are already at high level.

Obviously this is what “markets” want now . But given multiples examples of past and recent markets failures should we really consider this as a proof of success ? (just as a quick reminder, Greece crisis is as well due to the fact that investors have been lending to much money and at the wrong price to Greece in the early years of the Euro). One could as well argue that what “markets” want is at the bare minimum to avoid loss on their investments and will approve any proposal that meet this objective . But the long term benefits for the lenders don’t really enter in their analysis for investing.

Not to say that the solutions currently applied in Europe are perfect and faultless . But at least they are based on the sound principle that you should not spend (to much) more than what you have or can reasonably think to have in a relative close future.

Posted by romblanch | Report as abusive

[…] Read the article Share this:TwitterFacebookLike this:LikeBe the first to like this. Published: July 19, 2012 Filed Under: Economy, Euro Crisis Tags: economy […]

Posted by How to solve the Euro Crisis in one easy step « Leading Articles | Report as abusive

[…] Can a real central bank save Europe? […]

Posted by Kenya MPs want minister,cbank governor probed in money printing row « Acbnews ‎Online:@Acbnews:Follow and Retweet and you could win Kshs 10,000,WINNER TO BE ANNOUNCED ON @ACBNEWS ON TWITTER ON SEPT 9TH OF 2012. TO ADVERTISE ON OUR HOMEPAGE FRONTAL | Report as abusive

From all I have read there are a few things that would make a huge difference in all countries with big debt.

1. Get rid of the massive waste in government spending.
2. Get rid of the corruption of both in the Government and
Corporate world.
3. Make the tax system fair.
4. Collect the taxes.

Make the cost of breaking these rules so damn tough people will think long and hard before they break them. But when they do land on them like a ton of bricks. It’s loss of property and jail time for CEO and CFO plus huge fines.

Posted by JLWest | Report as abusive