Opinion

Hugo Dixon

ECB and euro governments play chicken

By Hugo Dixon
June 4, 2012

The euro zone crisis is a multi-dimensional game of chicken. There isn’t just a standoff between the zone’s core and its periphery; there is also one between the European Central Bank and the euro zone governments over who should rescue the single currency. In such games somebody usually blinks. But if nobody does, the consequences will be terrible.

The brinkmanship between the governments is over how much help the northerners, led by Germany, should give the southerners. The core is effectively threatening the peripheral countries with bankruptcy if they don’t cut their deficits and reform their economies. The periphery is saying that, if they collapse, so will the entire single currency which has been so beneficial to Germany’s economy. The game is being played out transparently in Greece and covertly in Spain.

But even if the core eventually decides to help the periphery, there is a struggle of whether the aid should come from governments or from the ECB. Politicians would like the central bank to do the heavy lifting to avoid having to confront taxpayers with an explicit bill. But the ECB doesn’t think it is its job to help governments, arguing that such support violates the Maastricht Treaty.

This standoff is making it hard to devise a Plan B to cope with what is now a clear and present danger: an explosion in the euro zone.

Look at the most immediate problem: what to do if the “jog” out of Greek bank accounts accelerates into a run. The ECB’s exposure to Greek banks is about 125 billion euros – through a combination of its normal liquidity operations and emergency liquidity assistance (ELA) provided by Greece’s central bank.

The Bundesbank, Germany’s hard-line central bank, says the eurosystem, the collection of national central banks, shouldn’t increase its risk level in Greece. Instead, it wants governments to guarantee any further liquidity injections. But the politicians don’t want to face that issue, at least until Greek voters have given a clear answer over whether they want to stay in the euro.

The snag is that the June 17 election may not provide a clear answer and that might provoke a bank run. At the moment, there isn’t a plan of how to respond. Would the ECB blink and authorise extra ELA – in which case it would look remarkably silly if Greece then quit the euro and the central bank faced massive extra losses on its exposure? Or would it shut off the tap – in which case cash withdrawals from Greek ATMs would have to be rationed, quite possibly provoking panics elsewhere?

The difficulty coming up with contingency plans goes beyond Greece. What, for example, should be done if bank runs do spread to other countries such as Spain and Italy? Mario Draghi, the ECB’s president, last week gave what might seem like a reassuring comment to the European Parliament, saying: “We have all the means to cope with this as far as solvent banks are concerned”. What he didn’t spell out, though, is how the ECB would react if there were runs on insolvent lenders.

There would probably be brinkmanship. The ECB would argue that it was the governments’ job to recapitalise their banks. The politicians would try to avoid injecting taxpayers’ money into their lenders, not least because the governments don’t have the cash. The ECB would then probably say the governments should borrow money from the European Stability Mechanism (ESM), the euro zone bailout fund.

The politicians might come up with inventive schemes, such as giving their banks IOUs which could then be swapped with their own national central banks for ELA. That fudge was used two years ago to recapitalise Ireland’s banks – and Spain was originally toying with a variation on the theme to shore up Bankia. But the ECB doesn’t like it, not least because ELA is supposed to be only temporary.

On the other hand, if neither side blinked, some banks could collapse – triggering runs even among solid ones.

Yet another weakness in the euro’s defences is what to do if investors refuse to buy Spanish and Italian government debt. Madrid, for one, wants the ECB to step in with massive purchases of its bonds through what is known as the securities markets programme. The central bank, though, thinks it should do this only to a limited extent and that if a government needs cash, the relief should come from the ESM, that is from the other governments.

The snag is that the bailout fund doesn’t have enough money to rescue both Madrid and Rome. That’s why France and other countries have argued that it should be allowed to borrow money from the ECB – back to the central bank again. But Draghi has rejected that idea, saying that it would constitute “monetary financing” – or bailing out governments by printing cash – which is forbidden by the Maastricht Treaty. Others argue that the legal position isn’t so clear.

Either way, another potential standoff is being set up. If Italy lost access to the markets and the ECB didn’t blink, then Rome would have to turn to extreme measures: force its citizens to buy bonds, suspend debt repayments or something else. That would be a pretty hairy moment, which might spell the end of the single currency.

Of course, all hell might not break loose. And, if it does, some clever compromises might be found. But multi-dimensional chicken certainly heightens the risks.

Comments
6 comments so far | RSS Comments RSS

nice try at ruffling feathers

but the markets have already spotted a turkey beneath the axe

the english pound sagging under the weight of Uk’s double recession, depressed manufacturing …..

Posted by scythe | Report as abusive
 

What doesn’t get much press is the arcane entanglement of various derivative “investments” in the European banking system. I wouldn’t be surprised if there is still no complete accounting of each bank’s off balance sheet liabilites. And yes, US banks and insurance companies have their hands in the mess too. A Greek exit and/or default will shed light on this steaming pile and will precipitate an unhappy chain of events. Can’t blame people for grabbing their cash while they still can.

Posted by gordo53 | Report as abusive
 

LOL, these high and mighty germans are living in a fools world. Better they walk out of euro and kill it. UK had a circus with the queen still trying to attract FUNDS, yuck. Olympics and euro are atleast better money pullers. Problem is UK and germany want money for NOTHING, and thats gone. Wonder what magic persuaded the stupid greeks and spaniards to give up their independence for the euro. I mean you live off your work and look at all gift carriers with a mite in the eye. But greeks bought german gifts and now should go out without a whimper. They are finished. Maybe china will own greece tomorrow, picking it up pretty cheap.

Posted by kpvidya1999 | Report as abusive
 

if the Germans are playing ‘GOD’..good for them…but when the financial system of nations rest on your shoulders..you don’t treat your worshipers this way..pushing responsibilities and pointing fingers…Greece’s exit from the euro zone will favor neither party… and neither will Spain’s and Rome’s exit.Let’s see what happens when ‘the puppets’ start daring their master….

Posted by yisa570 | Report as abusive
 

Having a single currency and monetary policy that works forever, requires that all the majority of the voters want the same in that. That means a single economy that is good for all. That requires Europe wide business laws and courts. The schools teaching the same idea of public good and what is graft. I am sure in some parts of Europe someone not taking care of his extended family at public expense if had the power is bad, in other parts just a honest person. For the nations to be at same economic stage they would need workers with about the same education level and health. If not at the same economic stage they need different monetary fiscal policies.

Posted by SamuelReich | Report as abusive
 

where the Germans enjoy playing god but at the same are not ready to listen to the prayers of their worshipers.This issue is a two-way thing…its either everybody stays in the euro zone…..or the euro leaves everybody.

Posted by yisa570 | Report as abusive
 

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