By Marshall Auerback, a portfolio strategist and fund manager
Wolfgang Munchnau is right. Only a closer union can save the euro. In the longer term, it will be necessary to put in place a permanent fiscal arrangement through which the central euro zone authorities distribute funds to be used by member nations. Ideally this should be in the hands of the equivalent to a national treasury responsible to an elected body of representatives—in this case, the European Parliament.
But politically, this is a non-starter, particularly in today’s environment. Germany in particular would only accede to a “United States of Europe” run on German lines, in effect making the euro zone a “United States of Germany” or, at the very least, a European Union with strongly German characteristics.
Enter the European Central Bank: With little fanfare, the ECB has been responding to the EMU’s solvency mess by conducting large-scale bond purchases in the secondary market (which, unlike direct purchases of government debt, is not contrary to the Treaty of Maastricht rules) for the debt of the EMU nations. As Bill Mitchell has noted, it is remarkable how little press coverage this has generated, but despite saying there would be neither be bailouts, nor unsterilized bond purchases, the ECB is now buying huge amounts of PIIGS debt to ensure the funding crisis in the EMU is contained. Given that this substantially reduces the insolvency risk, this is probably a wise policy, although it does little to address the underlying design flaws in the system which we have discussed before.
But there are fundamentally anti-democratic overtones in the action. Perhaps financial coup d’etat is too strong a characterisation, but there is no question that ECB is now by far and away the most powerful institution without peer in the EMU. As Mitchell argues, “they stand between the system collapsing or muddling through. And they can force austerity onto citizens throughout the member nations but never face the judgement of the voters.”
Which is why we think that questions about the success of the ECB’s alleged sterilisation policy is besides the point: the ECB is finally responding to the euro zone’s potential solvency mess by conducting large-scale bond purchases in the secondary market (which, unlike direct purchases of government debt, is not contrary to the Treaty of Maastricht rules) for the debt of the EMU nations.
The Eurocrats, who have always found democracy to be antithetical to “sound economics” and “good policy”, now have the opportunity of using this crisis to ram through their vision of Europe, which is fundamentally anti-labour and pro capital.
In economic terms, this action is the same as Warren Mosler’s proposed revenue sharing proposal, although it is not done on a per capita basis, and is potentially rife with moral hazard, since it can theoretically mean that the biggest spenders – who will issue the most government bonds, which can then be bought by the ECB in the secondary market – are rewarded However, the ECB can eliminate this moral hazard problem simply by indicating to miscreant countries that it will refuse to buy their debt in the secondary markets if it does not continue to adhere to “responsible” fiscal policy. By embracing this quasi-fiscal role, the ECB in effect becomes the “United States of Europe”. The ‘distributions’ the ECB will make will be via buying enough national government debt in the secondary markets to keep the national governments solvent and able to fund their deficits, at least in the short term markets.
The reality, then, is that the ECB has become the political arbiter for fiscal decisions made by each of the euro zone national governments. If the ECB determines that any member nation is not complying to their liking, they will start threatening to stop buying their debt, thereby isolating them from the ECB credit umbrella, while allowing the remaining nations to remain solvent. And soon the bureaucrats who run the ECB will realise that the non-sterlisation of the bonds doesn’t create inflationary pressures and they will keep doing it, as they will find it to be a very powerful tool to keep national government spending plans which they don’t like in check. ECB spending on anything is not (operationally) revenue constrained as the member nations are, so this policy is nominally sustainable, even if fundamentally undemocratic.
The austerity measures which will be enforced (and thereby secure the tacit backing of Germany) will result in lower growth, and maybe even negative growth, but the solvency issue is gone as long as this policy is followed. With the ECB in effect backstopping the bonds of the national governments, it facilitates the latter’s ability to secure funding again in the market place via renewed bond issuance.
With currency stability developing and inflation ultimately a function of fiscal balance, the fundamental forces in place that drove the euro substantially higher against the US the dollar earlier this year might reassert themselves as private portfolio preferences shift back toward the euro, especially as the mechanism to remove the default risk that drove the portfolio shifts that weakened the euro is now in place. Dollar aversion could well be heightened by renewed fears of a double-dip recession in the US.
If we were to hazard a guess, we would suggest that euro denominated risk assets would outperform US assets for the balance of this year. Another possible investment outcome in the short term is a potential fall in the price of gold (the positive price action until recently has hitherto acted as something akin to “euro vaporisation insurance risk”) As the perceived euro insolvency/evaporation risk diminishes, gold holders who bought on this basis could well shift their money back into euros.
Power, then, has shifted inexorably to the ECB, presumably under substantial influence of the national government finance ministers (ECOFIN), as the ECB directly or indirectly moves to fund the entire banking system and national government. deficits. This is an institutional structure that is fully sustainable financially, with the economic outcome a function the size of the national government. deficits they allow. There has been increasing evidence in the last few weeks or so that suggest that the public deficits across the EU are propping up demand just enough to stop a depression scenario. Growth in Europe though extremely weak is positive, exports are picking up (for now), and there is some evidence that the falling euro will continue to help the external sector.
But the actions of the ECB are neither politically desirable, nor sustainable over the longer term. The conflict will remain the money interests in Europe who put currency strength as a priority, versus the exporters who favor currency weakness. The consensus will be that unions and wages in general must be controlled, which will create ongoing social turmoil. That’s not a great environment, especially in the “new normal” of subpar returns on financial assets.