Can you buck the markets?
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
LONDON — Can you buck markets? Margaret Thatcher said you couldn’t; Angela Merkel, by contrast, believes in the “primacy of politics”. Who’s right depends on whether politicians have the will to change the unpleasant reality that markets can reflect. The euro crisis is testing this theory to destruction.
In one sense, Britain’s iron lady was right. Markets are messengers — sometimes of doom, at other times of glad tiding. Actions like restricting short-selling of financial stocks, Merkel’s bright idea in May, are pointless. They don’t change reality. Even intervention in the markets — such as the European Central Bank’s sovereign bond-buying programme, which restored calm late last week — only buys time.
Germany’s iron chancellor is also right that politicians can prevail, but only so long as they change what markets are worried about. The euro zone’s volatility is largely due to lack of clarity over whether the authorities have the will to tackle excessive debt loads and uncompetitive economies. Solutions are available, but there are multiple actors with competing visions.
Take the ECB first. Mere bond-buying won’t save the situation. But if the central bank was prepared to take big risks with its own balance sheet, or abandon its policy of not creating inflation, that would be a different matter. It could then hoover up a few trillion euros of debt and allow the money supply to expand commensurately by not “sterilising” the operation.
Such a move, similar to what the U.S. Federal Reserve did after Lehman Brothers went bust in 2008, might change the reality. Insofar as it drove down governments’ cost of borrowing and reduced the risk of deflation, it would make debt burdens easier to bear; insofar as it pushed down the euro, it would help boost the euro zone’s competitiveness.
But Jean-Claude Trichet, the ECB’s president, doesn’t want to go this far. If there’s to be a bailout, he wants stronger governments to do it by the front door, rather than the central bank to do it by the back door. That is why he is pushing for an increase in the size of the euro zone’s rescue fund.
Such a scheme might again do the trick, especially if funds were made available on even more favourable terms. A plan for euro zone governments to issue common bonds — making them responsible for each other’s debts, as proposed most recently by the Italian finance minister and the Luxembourg prime minister — might also change reality. In either case, weak governments would shift some of the responsibility for their debt burdens to stronger ones.
But here it is the turn of Germany and other stronger countries, led by Merkel, to balk. They don’t want their citizens to suffer. They want the weak countries to bear the lion’s share of the pain of adjustment. This year they have pushed peripheral economies to embark on a series of structural reforms which, when judged cumulatively, is starting to look impressive: curbing deficits, fighting corruption, pushing up state retirement ages, freeing up labour markets, shrinking banks and reducing generous welfare benefits.
Greece, Ireland, Portugal and Spain, though, have had to be dragged — sometimes kicking and screaming — into adopting these policies. And although structural reform will help, it won’t necessarily save the situation. Debt levels are so high that some sort of rescheduling may still be needed.
This is where investors dig their heels in. They don’t want to suffer haircuts on money they have lent either governments or banks. Every time somebody, normally Merkel, suggests they do, markets suffer a conniption. Politicians then get so scared that trouble will spread closer to the core that they typically back off. That’s what happened last month with Irish bank debt.
We are witnessing a game of chicken. All the principal actors — the ECB, strong countries, weak countries, even bond investors — want a peaceful solution. But they want to bear the fewest costs themselves. Most games of chicken end in a negotiated settlement. That, too, is the likely outcome with the euro: a bit more inflation, a weaker currency, more belt-tightening by peripheral countries, more handouts from the core and some haircuts for bondholders. If so, the primacy of politics will, indeed, have been asserted. But every so often games of chicken spiral out of control. If that happens this time, the politicians will be bucked big time.