Drowning the euro in dogma
«German orthodoxy ignores the possibility that rising bond yields are being driven by a self-fulfilling panic in financial markets. Investors who once regarded Italian bonds as a safe asset now worry about everything from the integrity of the credit-default-swap market to a possible break-up of the single currency. The result is a stampede for the exit, which cannot be stopped by Italian policy reforms alone. So by adding to the pressure on the governments of countries in crisis, the Germans and their allies succeed in forcing reform, but at the cost of making it far harder to rescue the euro.
Emerging economies which borrow in a foreign currency have long been vulnerable to these kinds of self-fulfilling crises of confidence. As the pool of euro assets deemed “safe” dwindles, more countries may face such runs. Judging by this week’s leap in yields, France looks to be next in line. The big difference, however, is that average emerging-market debt is less than 40% of GDP. Italy’s debt ratio is more than three times higher; France’s twice as high.
The euro zone’s most recent plan—to amplify the existing rescue fund with financial engineering and money from China—has failed miserably. That leaves two alternatives. Either Europe’s governments will have to assume explicitly some joint liability for each other’s debts. Or they will have to do so implicitly, by allowing the ECB to counter a panic with purchases of government bonds: in effect, letting it act as a lender of last resort. The danger lies in eschewing both options.
Each route has risks, but both are exaggerated by the German dogma. With demand weak and the fiscal vice tightening, it is hard to see an imminent danger of inflation. In theory, if joint liability was designed properly, errant countries would be stopped from going on a bender at other Europeans’ expense. But such rules are hard to craft, and Europe’s governments move slowly. For the foreseeable future, the ECB is the only institution that can staunch market panic quickly. The ECB could still keep pressure on the likes of Italy, and prevent them from backsliding on reform, by making sure that its support was at a sufficiently punitive interest rate.
Technically, there are ways around German opposition. Mr Weidmann, for instance, could be outvoted at the ECB. But, in practice, any solution must be blessed in Berlin. That is why Mrs Merkel must make the case for greater pragmatism. Otherwise Teutonic rigidity will wreck the European project.»
[The German problema, Economist 19-11]
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