Geithner’s fudge won’t kill the euro zone debt Ouroboros
The frosty reception given to US Treasury Secretary Timothy Geithner at the ECOFIN meeting in Poland last week tells you all you need to know about what is wrong with the EU. The hostility was directed not at the feebleness of the advice he had to give, but at the right of an American passport-holder to offer any advice at all to the policymaking elite of Europe, who are so obviously capable of handling the crisis themselves without any outside assistance.
As far as I can tell, Geithnerâ€™s proposal amounts to leveraging the EFSF so that it can be inflated to a level sufficient to assure the markets that it has the resources to do the enormous job it has been given: bailing out Greece, Ireland, Portugal, Â Spain, probably Italy and maybe even France at some point.
So, as ever, the American solution to the problem of excess leverage isâ€¦ even more leverage. Financial wizardry is what Europe needs now â€“ after all, it worked so well last time aroundâ€¦Â Risks? What risks? The additional borrowing will be guaranteed by the ECB, whose credit is cast-iron, so problem solved. Why did it take them so long to come up with an answer?Â If only it were so easy. Ask yourself: why is the ECB so creditworthy in the first place?
Not, in the final analysis, because its borrowing is backed by the governments of Greece or Portugal or Spain or Italy, nor even because it is backed by the Netherlands or Finland â€“ however fiscally responsible they may be, they are simply too small to stand behind Europeâ€™s central bank. In a crunch (and if we ever doubted that crunches happen, we know now that they do) even French support could be inadequate, given that it is currently running a sizeable budget deficit and faces a presidential election in a few months.
No: there are two meaningful levels of support that give the ECB its pristine credit status.
Firstly, the backing of the German government was, until recently, enough to preserve the ECBâ€™s status as Son of Bundesbank. The trouble is that Germany itself has a debt-to-GDP ratio comparable to that of Britain, and the ratio would be a lot higher if it included commitments already made and about to be made to support weaker euro zone member governments.Â Moreover, even if they still have the capacity to do so, it is hard to see why the Germans would want to shoulder the bailout burden in this barely-camouflaged form when they are apparently so wary of entering into a more explicit transfer union (as they call the nightmare scenario of a Europe in which they are doomed to subsidise everyone else in perpetuity).
There is a second-level backstop for the ECB, and it is the one which I suspect will be called upon in the end. Although it is subject to all sorts of nominal restrictions on its freedom of action to reflect its multinational character, which have served to prevent it ever being free to behave like the Fed, the ECB is ultimately a central bank and, as such, it can always be given the green light to print Euros in whatever quantity is required to pay its debts or simply to cover the cost of more loans. The Geithner proposal amounts essentially to freeing the ECB from some of its existing constraints and preparing it to monetise Europeâ€™s fiscal deficits, a policy similar to that which the Obama Administration itself has pursued vigorously so as to fund massive bailouts of Fannie Mae, Freddie Mac and other basket cases, with results that have been at best extremely mixed.
The effect of printing euros will sooner or later be another fall in the common currencyâ€™s internal and external purchasing power, equivalent to a tax on all money holdings, thereby neatly spreading the bailout burden across the euro zone to debtor and creditor countries alike.
Why on earth should the Germans agree to any of these schemes? From their standpoint, they all suffer from two essential weaknesses. First, they punish the guilty with the innocent, and secondly, they provide no incentive for the innocent to go straight â€“ the very opposite, in fact.
That, even now â€“ with the terms of their rescue deal still uncertain â€“ the Greeks are showing great reluctance to do what is required to get their budgets under control and make their domestic economies competitive, bodes very ill for the future. Â Post-integration, how long will it take before the other member countries get the message that fiscal discipline is unnecessary self-flagellation in a system where spenders are winners and savers are suckers? My guess is that Ireland is every bit as unique as its tourist board would have us believe, and that the majority will follow the Greek example (look at Italyâ€™s ongoing commedia delâ€™austerita if you have any doubts on this score).
What about the oft-repeated argument that it is somehow in Germanyâ€™s own interest to preserve the euro zone?
There is an awful lot of nonsense talked about the benefits Germany supposedly derives from European Monetary Union, most of it based on the standard Europhile con trick of quoting gross trade or employment figures, implying that the whole lot is under threat if the euro zone breaks up. The reality is, of course, that Germany exported a lot to its neighbours before the euro zone was ever conceived, and it will continue to do so if or when the euro zone is dismantled. A break-up might see a greater proportion of its trade going to countries outside Europe â€“ USA, China, Russia etc â€“ but so what?
In fact, it is far from clear that Germany has derived any net benefit from EMU since its inception in 1998 â€“ and, even if it has benefitted in the past, there is no reason to suppose it will continue to benefit in the future. The major beneficiaries of EMU have been the ClubMed countries which, thanks to the creditworthiness conferred by euro zone membership, were able to borrow far more than they could ever hope to repay from reckless bankers in France, Germany and Britain. (Not only similar to the way many householders in the US and UK were able to live beyond their means thanks to mortgages, but often provided by the very same bankers who so generously funded Greece et al).
In the end, however, we need to remember that politics will always be more important than economics, and it is the politics which worries me most, because it looks as though democracy is going to be sorely tested in some countries, possibly to destruction.
Consider the dilemma facing German voters. On the one hand, they are deserting Frau Merkel, because she seems indecisive, with no clear vision of how to use Germanyâ€™s overwhelming economic weight to shape Europeâ€™s future. On the other hand, as taxpayers, they are (not surprisingly) afraid that she may succumb to the pressure to saddle them with the burden of carrying the rest of the euro zone.Â The upshot is that they are deserting the Chancellor in large numbers. But where can they go? Many seem to have transferred their allegiance to the opposition SDP, in spite of the fact that it is far less likely to resist the pressure than Frau Merkel is; and even more amazingly, to the Greens, whose demented lust for all things European makes Britainâ€™s Lib Dems seem almost sane by comparison.
So who can the millions of German voters opposed to further integration â€“ 70% or 80% of the electorate according to the opinion polls â€“ turn to?
There is no need to worry about Germans defecting in large numbers to the Far Right in the immediate future (as has happened in Finland, Denmark, France and other countries, where anti-immigrant parties have exploited the space left by the refusal of their mainstream parties to contemplate anything beyond the current Brussels orthodoxy); but if Germanyâ€™s political class does give in and agree to foist some form of fiscal-integration-by-the-back-door on its reluctant electorate (whether by euro bond, the Geithner fudge, or some other method yet to be devised), we need to ask what will happen when German voters wake up to the reality of the commitment made in their name. How will they react to paying reparations yet again â€“ this time, only for the crime of thrift?
Like the Bourbon kings, Europeâ€™s political class appear to have learned nothing and forgotten nothing.