I’ve been worried for quite some time that the European Central Bank was losing its independence, thus undermining the long-run prospects of the euro.
Well, yesterday’s announcement that the ECB would buy the dodgy debt of nations such as Spain didn’t make me feel any better.
Central banks should not be bullied into creating too much money simply because politicians are too corrupt, venal, and short-sighted to control spending.
Here is some of what Allister Heath of City A.M. wrote earlier today. He begins with a wise warning about moral hazard.
There is nothing markets love more than a good dose of monetary activism, especially when they detect a hidden bailout, so it is no wonder that traders and investors reacted so positively to Mario Draghi’s bond buying plan. …Yet generally speaking these days, the more the markets like a central bank intervention, the more I worry. This is because all too often investors are trying to get central banks – and ultimately, the taxpayer – to monetise debt to protect themselves, or because they believe that there are monetary solutions to real, structural problems. I disagree on both counts: excessive debt needs to be written off, with the cost born by the creditors, not redistributed to the taxpayers of more prudent countries or inflated away. It is right that investors should be able to make a fortune if they make a correct bet – but it is equally right that they should lose their shirt when their investment goes sour. This habit of quietly enjoying the former but loudly refusing the latter is one of the main reasons why the City’s reputation is at such a low ebb.
He then explains that the ECB shouldn’t try to mask reality.
…there is a perfectly good reason why the yields of peripheral Eurozone nations have shot up over the past year. It is because the markets have finally started to price risk properly. Higher yields on Spanish or Greek debt reflect the reality of deeply troubled, structurally uncompetitive nations… The market is sending a clear and precise signal, and warning the world that there is a major problem that needs resolution; buying vast amounts of bonds to try and distort or even entirely eliminate that signal and pretend that nothing is wrong with Europe’s weaker economies would be an absurd act of delusion.
I’m not as optimistic as Allister is in this next section, largely because the supposed conditionality will lead to the kind of fiscal gimmicks and moving goal posts that we see in Greece.
…while there are many problems with Draghi’s plans, he is actually being relatively sensible. He will not help Portugal, Ireland and Greece until they are able to access bond markets; even more importantly, Spain and Italy will need to ask for European bailout fund support, and accept the ensuing conditionality, before ECB bond-buying starts. It will theoretically be unlimited in scale but Draghi only wants to “do whatever it takes” as long as politicians toe the line. Given that they won’t, and that many countries will soon be borrowing even more, the crisis will soon flare up again. The simple reality is that the Eurozone in its current form is doomed. Draghi’s plan will buy some time, and his next one even more, as will the one after that. But eventually the size of the fiscal and competitiveness crisis, combined with voter anger in both Northern and Southern countries, will overwhelm all of his attempts at papering over the cracks. It’s just a matter of time.
But I obviously agree with his conclusion. Unless European politicians decide to reduce the burden of government spending, the continent is in deep trouble.
Last but not least, the problem in Europe is not the euro. It is the welfare state. I’m not a huge fan of the single currency, but it is way down on my list of reasons that nations such as Spain, Italy, and Greece are in trouble.
P.S. America will be in the same boat at some point in the future if we don’t reform entitlements.
P.P.S. Allister is the author of this great article explaining why tax competition and tax havens are so important and valuable in the global economy.
