May 10, 2010
The only thing that will stop Ireland – and a number of other EU countries – from defaulting on their debts is if the European Central Bank bites the bullet and starts printing money to buy up government debt in Europe in limitless quantities.
This is what we have come to. Anything less and the financial markets will keep selling European sovereign debt.
Today we will hear what EU governments have decided to do. Some kind of EU stabilisation fund is promised. However, unless there is a major move by the ECB to buy government debt, the crisis will deepen.
This must be driving the Germans mad.
However, they went into this euro adventure with their eyes wide open and, now that their worst fears have been realised, it is beginning to look like they are on the hook for the whole thing.
Worse still from the German perspective, their banks, which had been exemplars of prudence for years, are now up to their necks in the government debt of delinquent nations – debt which no one wants. The only buyer of downgraded sovereign debt – Ireland’s included – is the European Central Bank (ECB).
In order to save the finances of Ireland – and the interests of Germany’s banks which are owed â‚¬127 billion by Irish banks – the ECB has to do what our government did back in September 2008,when it guaranteed the banks. The ECB now has to guarantee all the government debt of Europe. Anything less and the financial markets will run a mile from all nonGermanic government debts, precipitating mass sovereign default all over Europe.
As a consequence of this realisation, we are facing Credit Crunch Mark II. This is because fear has once again replaced greed, and the contagion has spread. At the beginning of last week, investors were rightly worried about how much sovereign debt was on the books of the large German and French banks. The EU put together its mega-package to bail out the banks that had exposure to Greece, but the markets brushed it off because they realised that the banks were contaminated.
Europe is now back to the situation where the US found itself after Lehman Bros collapsed, because the banks don’t trust each other. Certain European sovereign debt is the ‘sub prime’ of 2010, and the banks won’t lend to each other until they know who has this trash on their books and how much of it they have.
This will cause a double dip, because the new credit crunch will simply squeeze business, and the whole of Europe will face the capital constraints that Irish business faces at the moment.
We will then see reverse contagion: the bond markets drive the money markets which in turn drive the bond markets down further, which begets more capital flight from the bond markets.
The cash will just end up back in the central banks because, without trust, we will end up with loads of money, but nowhere to invest it. So we will have money alright, but no credit. So the money markets are seizing up as well as the bond markets, which are now shut to Greece. The door is also closing on Ireland, Spain and Portugal. But it won’t stop with us.
When the banks stop lending to each other, someone else has to. This is where the ECB comes in. Having prevaricated for weeks, the ECB will now have to throw caution to the wind and print money. It will have to orchestrate Europe’s own Tarp – a ‘cash for trash’ scheme – which sees the central bank bailing out every government in Europe.
It will be a type of continent-wide Nama where, instead of buying loans underpinned by land, the ECB will buy loans underpinned by each country’s ability to pay tax in the future.
But the problem with this is that, as long as the countries can’t devalue their currencies, they will have to get competitive by enduring long and painful falls inwages. Most workers won’t put up with this carry-on indefinitely. As the economies contract, their ability to generate revenue to pay the extra interest of the new loans falls. So the ECB doesn’t so much lend money to governments as give it to them.
This will open the floodgates to inflation because, with so much money injected into the system, there will ultimately be nowhere for that cash to go except into the price of real stuff.
Germany can’t insulate itself from this.
The Germans face two appalling vistas.
The first is staying with the euro but not allowing the ECB to buy up all the dodgy government debt. In this case, the periphery defaults, and the German taxpayer has to write a cheque for the German banks that will be dragged down by the meltdown.
The second choice Germany has is to allow the ECB to print money and therefore abandon the obsession that Germans have with low inflation.
Either way Germany loses. Not as much as we do, but it loses nonetheless. At some stage, the Germans have to ask: ‘‘What’s the point?” They were perfectly happy with the deutschemark and could be again.
They only signed up to the euro to get permission from the French for German reunification. Now that reunification is history, what’s to stop the Germans reconsidering the euro? After all, the only way they can insulate themselves from the mess in Europe is by leaving the euro.
Such an event is unimaginable, even in the face of today’s crisis. But if the remedy doesn’t resolve the inconsistencies at the heart of the euro, the problem will just resurface again and again. Is such a construction worth keeping?
All this is reminiscent of the collapse of the USSR. The powers, the politicians and all the experts were caught on the hop. No one believed that it would collapse overnight, yet it did. I was in the Soviet Union in 1990 trying to learn Russian and, although there was a sense of something happening, very few Soviet citizens whom I met imagined the country would break up.
A decade and a half later, in the most exciting day of my journalistic career, I interviewed Mikhail Gorbachev for a programme I presented onTV3 called Agenda. He was my hero, yet I couldn’t shake off the feeling that here was a man who understood the problems but couldn’t see that there was no solution to the problems within the parameters which he was prepared to consider. He had to think the unthinkable, but he couldn’t. The Soviet Union disappeared, and life went on.
If the euro goes – which is still only a small risk, given political inertia and the fact that big individual and institutional reputations are tied up in the project – life would go on. In fact, there are those of us who believe that Europe would thrive economically without the euro, in the same way as the Asian Tigers expanded after the devaluations that followed the Asian crises of 1997/8.
This is a minority view now, but wait till the Germans realise that their politicians have waltzed them up a financial cul-de sac and that the only way out is inflation.