The euro tragedy is reaching its bloody end with Greece
Only the new head of the European Central Bank can prevent disaster – but will Mario Draghi do what’s needed?
We have reached the final act of the revenge tragedy that is the eurozone crisis. We’ve had the melodrama, the comic flourishes, the lunatic interludes - but there’s still no telling how it’s all going to end. If it remains true to the genre, it will be in an orgy of murder and violence.
The plot so far? We know that the single currency as presently constituted only really works in benign economic conditions, and so was very probably doomed from the outset. We know, too, that the leading players won’t yet accept that fact, remaining locked in a state of denial. And we also know that everything they’ve tried to correct the problem hasn’t worked. On the contrary, it only seems to have made matters worse.
That Europe’s leaders might be adopting the wrong policies doesn’t seem to have occurred to them. But then, the euro appears constitutionally incapable of allowing them to pursue the correct ones. The virtuous nations of the single currency’s core want only to impose self-defeating penury on the wicked of the periphery.
As it is, the mass slaughter that finishes all true revenge tragedies has begun. By calling a referendum on the bail-out package, Greece has hit the ejector button. It’s a small economy, and a default wouldn’t much matter, despite the damage to the eurozone banking system, if everything else was fine and dandy. But it’s not. The problem is that Greece is but an outrider. Bond yields in Italy, the world’s third largest sovereign debt market, have risen to levels that require it to take on more debt just to service the existing stock. Nobody’s got any faith in Italy’s ability to live up to its promises. The corruption of its bunga bunga economy constantly triumphs over efforts at reform.
All that’s now required to bring matters to their calamitous close is a Kreditanstalt-type event - this being the name of the bank whose collapse in 1931 triggered the second leg of the Great Crash, and plunged the world into depression. Is there any way of avoiding such an outcome? Only if the European Central Bank radically changes its approach and acts swiftly to generate growth. Mario Draghi, its incoming president, is under enormous pressure to act. But he’s so hemmed in by doctrine and tradition that it’s not clear he will.
Two options are open to the eurozone in supporting its over-indebted periphery. Either the excess debt can be paid for by taxpayers in the more solvent core, or it can be bought up by the central bank.
To date, policymakers have been most reluctant to adopt either strategy. Instead, Germany and Co have acted as all creditors tend to when they want their money back, forcing ever more implausible levels of counter-productive austerity on their over-indebted neighbours. Any fiscal and monetary assistance offered has been half-hearted and insufficient.
Politically, it’s proving virtually impossible to persuade hard-working Germans to pay for profligate Greeks and Italians. The bail-out fund has thus been made too small and ineffectual to offer meaningful support. In any event, it is only there at all as a surrogate for the European Central Bank, which refuses to do its proper job as lender of last resort, and provide the unlimited liquidity necessary to douse the flames.
Again, there are good reasons for the ECB’s stance, not least that it is actually banned from direct purchases of sovereign bonds. Its intervention in the bond markets - where that debt is subsequently traded - to support the eurozone’s periphery may also be technically illegal, which helps explain both its limited scope and the sophistry of the explanations used. In any case, for the ECB to be funding government spending by even the most indirect route is a definite no-no for Germany, with its memories of Weimar hyperinflation.
Yet to prevent a crisis from spiralling out of control and causing an even greater mess, it is sometimes necessary for central banks to ignore even the best-intentioned rules. The instruction manual for this was written by the British businessman and journalist Walter Bagehot in the 19th century. He argued that in a financial panic, only the central bank has the ability to lend without limit - and therefore, only the central bank can convince investors that they’ve got nothing to worry about.
Bagehot’s theory, indeed, only described what the Bank of England had already done in practice. As the US economist Brad DeLong points out, the Bank broke its own charter by providing the unlimited funding necessary to fight the bust of 1825-6. Its actions drew fierce criticism in Parliament - not so dissimilar to that we see today whenever the ECB dips its toe into the sovereign bond markets.
There is a big difference between acting to stem a banking panic, and buying up the debt of essentially insolvent eurozone states. But the principle is the same - and if the current crisis is not to end in calamity, it’s hard to see the alternatives.