Are Eurobonds Inevitable?
“Whatever it takes.” Those were the words followers of the euro zone have been waiting to hear ever since Mario Draghi replaced Jean-Claude Trichet as head of the European Central Bank. To spell out the quote in full, Draghi said: “The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
Central bankers are famously gnomic in their utterances. This is, however, about as unambiguous as they ever get. Jean-Claude Trichet used exactly the same phrase in reference to his determination to put inflation control ahead of all other objectives, and he demonstrated it with policies that came to the edge of destroying the euro in order to save it from inflation. Draghi’s choice of words therefore amounts to, at the minimum, a sharp change of course.
Of all the actions open to the ECB, there is only one that is sufficiently big, and sufficiently controversial, to justify Draghi’s statement. That is a decision to buy the bonds of EU member states, if necessary printing euros to do so, and accepting the risk of higher inflation.
The same policy of quantitative easing has been adopted in Washington and London. Monetary expansion is not sufficient to promote a strong economic recovery (that would require a renewed round of fiscal stimulus combined with further long-term measures to strengthen the budget), but it’s necessary to avoid the kind of deflationary spiral now being observed in Europe.
The need for such a statement right now reflects that catastrophic economic situation in Spain. Despite years of painful austerity, the Spanish government shows no signs of being able to service the debts created by the global financial crisis and a series of bank rescues. So far, the direct budgetary savings generated by austerity have been more than offset by the loss of revenue that is an inevitable consequence of contractionary policies applied to an already depressed economy. The news that Spain, like the UK, is now in a “double-dip” recession confirms the failure of austerity.
It’s important to remember that Spain’s problems are not a consequence of government profligacy. In the years leading up to the global financial crisis, the government’s budget was in surplus; public debt, as a percentage of GDP, was less than that of Britain, France or Germany. Spain’s problems arose from a housing bubble financed by its banks, which in turn depended on loans from banks in other euro-zone countries, most notably Germany.
When Lehman Brothers collapsed in September 2008, the bubble collapsed, taking with it much of the Spanish banking system. The costs of rescuing the system in a depressed economy have driven the economy to the brink of collapse.
In this context, it is a fitting irony that Spanish economy minister Luis de Guindos is a former Lehman Brothers executive. Guindos is an archetypal example of the revolving door between speculative investment banks, central banks and economic ministries that has driven so much of this crisis. Goldman Sachs alone employed Draghi, Henry Paulson, Mario Monti (the technocratic prime minister imposed on Italy) and Mark Carney, chairman of the Financial Stability Board. Even more striking, the ultra-hawkish chairman of the German Bundesbank, Axel Weber, went straight from that position to the chairmanship of Swiss bank UBS, of which the New York Times recently observed “The bank’s recidivism [in financial misconduct] seems rivaled only by its ability to escape prosecution.”
Despite Weber’s departure, the Bundesbank, and its new chairman Jens Weidmann, remain as the chief obstacle to a policy of quantitative easing. The ECB was designed to be the Bundesbank writ large. Its exclusive focus on price stability was the price of German acceptance of the whole euro project. As a result, Weidman wields something close to a veto over Draghi’s actions, at least with regard to the purchase of sovereign debt.
Weidmann is known to be strongly opposed to this measure, but he is running out of political support. The idea that southern European countries could be pushed out of the euro has turned out to be a fantasy, so their capacity to issue debt must be sustained one way or another. Until now, it has been possible to extract payments from the more prosperous EU governments in return for increasingly stringent austerity policies on the part of recipients. But the scale of the financial disaster wreaked by the bankers has been too great to be fixed by these measures.
At this point, the only solution is to liquidate a substantial proportion of the unsound debt run up before the 2008 financial crisis and augmented by its subsequent mismanagement. Except in the special case of Greece, it’s too late to separate good loans from bad—the only option is to create enough liquidity to settle a large proportion of the debt. That would represent an abandonment of the premises on which the ECB was founded. If Draghi really means to do “whatever it takes” to save the euro, he has no choice.