Don’t leave Plan B too late

November 28, 2011

It is fashionable for pundits outside Germany to lambast its government, the Bundesbank and the European Central Bank for being inflexible or stupid or both. Can’t they see that all that’s needed is for the ECB to fire its bazooka by printing unlimited money, and the euro crisis would be over?

After spending a couple of days in Frankfurt and Berlin last week, my impression is that these three institutions are neither stupid nor totally inflexible. That said, Germany is still determined to try its current plan for solving the euro crisis, though it has little chance of working. And by the time the trio get round to implementing a Plan B, the euro zone could be in deep recession or even have exploded.

The current plan has three elements. First, the governments of troubled countries such as Italy and Spain need to implement structural reforms and austerity. Second, the zone’s fire extinguisher, the European Financial Stability Facility, needs to be got in good working order in case the fires in Rome and Madrid become uncontrollable. Finally, governments need to agree a treaty committing them to long-term budgetary discipline.

A month ago, this plan might just have worked. But investor confidence has now deteriorated so sharply that even promising new prime ministers in Italy and Spain haven’t been able to stop their bond yields rising. Meanwhile, Belgium has become the latest country to get dragged close to the danger zone, with the yields on its 10-year bonds approaching 6 percent. Even Germany suffered a failed bond auction last week. The fire extinguisher also looks faulty: plans to leverage up the EFSF so that it is big enough to bail out Rome and Madrid have run into trouble.

Even the proposed treaty, which Germany’s Angela Merkel has been trumpeting with much ballyhoo, is unlikely to do much to restore confidence. While investors will like the idea that governments won’t rack up excessive debts in the future, they might not be so happy about the austerity needed to get every country’s debts below the promised level of 60 percent of GDP.

What’s more, there’s no guarantee that the current treaty can be changed given that it needs unanimous approval not just by the 17 euro zone countries but also by the 10 other members of the European Union, such as the UK. In some cases, there may also be referendums, whose results tend to be unpredictable. This explains why Germany and France are now casting around for alternative ways of getting the same result — say by having new treaties signed by a smaller group of countries.

Given all this, pressing ahead with Plan A might suggest that the decision makers in Frankfurt and Berlin are indeed stupid. That would be true if they were sure it would work. But they don’t seem to be. Indeed, the German finance minister called for extra resources for the International Monetary Fund on Friday in seeming recognition that the EFSF on its own won’t be enough to bail out big euro zone countries. Nevertheless, the policymakers in Frankfurt and Berlin still think that everything in Plan A is still necessary or at least desirable, even if it proves insufficient to solve the crisis. It is, for example, really important to keep the pressure on the new Italian and Spanish governments so that they deliver on their potential.

What’s more, coming up with a Plan B is problematic given that the ECB is forbidden from directly funding governments. This doesn’t mean that there’s no way saving the euro if Plan A fails. There are, after all, various gimmicks that could be used to get round the prohibition on directly funding governments. One is for the ECB to lend to the EFSF, making its fire extinguisher fully functional. Another is for the central bank to lend to the IMF and let it then lend to Italy and Spain.

The problem is that either manoeuvre would be extremely controversial as well as possibly open to legal challenge. That’s not to say the ECB would never contemplate unusual measures if that was the only way of preventing the euro breaking apart. But it would seem that, even then, it would only do so if it had political cover.

Such cover is gradually coming. Following the scares of the past week, both Finland and the Netherlands — which, along with Germany, have been the strongest advocates of austerity — started to crack. The Finnish finance minister said that if there were no other alternatives, an increased role for the ECB had to be considered. Similarly, her Dutch counterpart said he’d prefer the EFSF to be strengthened but, if that didn’t work, other measures would have to be considered: “In a crisis, one should never exclude anything beforehand”.

Meanwhile, the ECB seems likely to offer some short-term palliatives. First, it is continuing with its programme of buying sovereign bonds in the secondary market as a way of preventing Italian and Spanish yields going through the roof — a programme that Berlin has studiously avoided criticising. Second, the central bank looks likely to offer longer-term money to banks as well as accepting more types of collateral in return for it — measures that should counteract to some extent a looming credit crunch.  Finally, it may cut interest rates again in December to reduce the deflationary potential of the coming recession.

Fingers crossed, such short-term palliatives will prevent an explosion until Germany implements Plan A and figures out that it isn’t working. But even in the best case, such an approach probably won’t be enough to prevent a nasty recession. Meanwhile, there’s the ever-present risk that a panic could trigger a chain reaction which even a Plan B would be unable to contain.


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Revelation 18 foretells of a one world economic structure that will be in place in the last half of the seven year Tribulation period and it will be headquartered in Babylon located in modern-day Iraq. The world leader – the Antichrist – will require all who want to buy or sell, in other words, to sustain life, they will be required to have an identification mark on their forehead or the back of their hand (Revelation 13:16-17). It seems very possible that a worldwide economic crisis could cause humankind to take this mark under an economic global governance. Bible prophecy will be fulfilled.

Posted by green76joe | Report as abusive

As always and forever, market confidence is key. When confidence fades, the exits get crowded and no plan…A, B, C…no matter how rational, will be sufficient to withstand the rush.

Euroland yields are blaring “no confidence”.

Posted by johnvos | Report as abusive

UK does not want an Euro success

Posted by Ragbon | Report as abusive

Hugo, your news of Plan A is a tad late. There is a slight whiff of fear, uncertainty and doubt here.

ECB euro bonbons are not being offered to those with a debt sweet tooth. Fiscal discipline is far more exciting and productive. Thank you bond markets.

Failed German bond auction? Less than inflation? They did well to sell 40% – well done.

It seems that the quantitatively-eased (US, UK) are going to be fiscally-challenged with the global downturn. Even worse, a turning of the screws for their economies. Chinese might help. ( 28/us-oecd-economy-idUSTRE7AR0FQ20111128  )

(quote) “With the Federal Reserve already flooding the financial system with liquidity, the U.S. central bank has even less room to act if the world’s biggest economy hits a downturn. That prospect was made all the more real by the failure of Congress to agree a deficit-reduction plan, without which deep spending cuts would be triggered … The resulting fiscal tightening, which would come automatically, would in our view likely generate a recession in the United States.”

“flooding” the financial system with liquidity- sounds ominous,
now that the Eurozone is happy to use the bond markets to discipline spendthrift politicians.

Did the Republicans and Democrats agree to any Plan?
Don’t hold your breath.

Posted by scythe | Report as abusive

@scythe: Good point, any money borrowed at the world markets at 2 % – below inflation – can be called a success, not a failure.

Mr. Dixon, overall a good article, however in all honesty you might want to add that plan A has achieved that the last three years EU budget deficits have evaporated…look, without supercommittee!

Posted by FBreughel1 | Report as abusive

Germany enjoyed the benefits of a relatively devalued currency. Here is the bill. Pay it or we are cutting up the Euro-card.

Posted by rlindsl | Report as abusive

“If those who made the bets for their own private gain aren’t forced to absorb the risk, then we don’t live in either capitalism or democracy; we live in a financial-fascist tyranny.”

Germany is being asked to go against it’s own long-term interests so this party/sham can be kept going. Just a little while longer for the banks to loot whatever is left and then leave the public holding the bag.

The politicians will try to transfer the cost of bailing out Europe’s banks to Germany.

Those who made the risky bets have diverted the risk to others: taxpayers or the general public who holds currency. The gains from the bets are private, and theirs to keep, but all the losses are distributed to the public via government bailouts or money-printing. The first shifts the losses to the taxpayer, and the second shifts the losses to everyone holding the currency being devalued.

Not only has the risk been palmed off onto unsuspecting chumps, the returns have been concentrated into the few hands that control the big bets. This is the ideal setup for the stupendous gains and zero risk that characterize crony-capitalism: make the big bets with leverage and borrowed money, and skim the vast profits. Then when the bets sour, demand a bailout from the Central State, the ECB, the Fed, etc., which promptly socializes the losses and distributes them over the entire populace of taxpayers or holders of currency.

Posted by TheUSofA | Report as abusive

-TheUSofA- Man, you hit it right on the head! What an awesome commentary you made. My god, I couldn’t have written it better myself. That so sums it up perfectly!!! Yes, today here in the U.S., Europe, and much of the world, we live in crony capitalist-fascist system dominated by a wealthy few, also known as the plutocracy. Consisting of a group of very weatlhy, very powerful families who lord their financial wealth to control politicians, central banks, and nations to do their bidding. Their central banking system they have arranged drains the wealth from the nations and peoples across the world. This central banking system will cause the economic collapse of the world, it is simply inevitable.

Posted by DanielCrickett | Report as abusive

TheUSofA, your remarks ring oh so true but help me understand what the alternative is. How do we in the US and the EU get out of this mess without burdening the general public with either these financial carpetbaggers bad dept leaving them with their profits or sinking ourselves with those who made the risky bets when they are forced to absorb their losses? As bad as Lehman Was this could be a thousand times worse.

Posted by DaudM | Report as abusive

Imagine a ponzi scheme where it was important to keep “investor confidence” to keep it a success.

Or a Mortgage where every year the people owning house borrow more money rather than pay anything back on bank loan… and the bank can’t really foreclose on the house, because the people living in it control the police, courts and military.

*That* is what much of western world is like right now, solution is *not* to keep investor confidence if that means just racking up more debt.

A solution has to solve the going in debt problem. Europe has to be able to deal with trade imbalance, similar story with US, etc.

Posted by multilis | Report as abusive

Goverments should not buy bad debt from investors, including other government debt.

One example is argentina when crippled with debt, they made investors take a hair cut, they depreciated their currency, and got back on feet.

Basically to balance things out, everyone in country takes a wage cut when unemployment is high, those in china get a pay raise, and trade should be balanced out, with similar amounts of goods going to china from somewheres, eg sell them food and luxury goods.

Posted by multilis | Report as abusive

If all you do is boost investor confidence and keep the imbalances and deficits, all you do is make the collapse of the ponzi scheme even worse and more crazy the possible revolutions and bloodshed.

French revolution, russian revolution, nazi germany were all partially triggered by out of control deficits and imbalances.

Posted by multilis | Report as abusive

The people who want the ECB to print all the money to buy these worthless Eurobonds, are the same people who were praising Alan Greenspan as he was inflating the housing bubble with low interest rates (easy money, printing money, however you want to call it ).
How is it possible that such people still have a say???

Posted by JustLogicNSense | Report as abusive

“That said,..”

‘That said’ is the new ‘At the end of the day’.

Source: Fast food writing academy

Posted by theantibush | Report as abusive

@ DanielCrickett
You know? The only candidate for US presidency that I have heard talk of doing away with the Federal Reserve and the banking system of central banks is Ron Paul. That said (@theantibush), vote Ron Paul!

Posted by brnwtrs7 | Report as abusive