Published in Business Spectator (Melbourne), 19 January 2012
It is one of the most used phrases in the eurozone crisis: Buying time. The measures taken by European politicians over the past two years have obviously not solved the problems. Instead, they provided temporary relief – sometimes for a few weeks, sometimes only for a couple of days. They literally ‘bought time’.
As consumers we know that buying something is different from getting it for free. There is always a price one has to pay for one’s purchases. Otherwise they would be gifts. And though this is a truism, the price of buying time is usually overlooked in the eurozone crisis. Instead, the criticism focuses on the timing, the size or the nature of the measures. ‘Too little, too late’ is a criticism that is much more often heard than ‘too costly’.
After years of bought time for Europe, the bill for holding off the crisis is escalating. The costs have risen so much that they cannot be hidden anymore. At the same time, it is becoming increasingly clear that not a single problem has been effectively solved. So the question is: Are we heading for a moment in the crisis when decision makers finally realise that buying more time is simply not worth the price?
Take Greece for example. For the past four years, Greek banks and businesses have been effectively cut off from international capital transfers. For the past two years, the Greek government has been unable to access capital markets. For both crises there have been temporary solutions. Private capital transfers have been replaced by the European Central Bank’s Target mechanism (Europe’s hidden doomsday machine, 22 November 2011); the Greek government has been kept afloat by EU member states and the IMF.
In both cases, the temporary stabilisation of Greece has come with a big price tag. Greece now owes the ECB about €100 billion through the central bank’s Target payments system; more than twice this sum has been committed to the Greek bailout packages. Despite this, the Greek economy remains moribund, there is no sign that Greece will return to capital markets, and the country’s eventual default looks like a certainty.
In other words, several hundred billions of euros have only delayed the inevitable without solving any of the underlying problems. Greece is no more competitive now than four years ago.
The same ‘time buying’ policies have been at play in Europe’s troubled financial sector. The Global Financial Crisis revealed two things: firstly, how risk had been systematically underestimated by market participants as evidenced, for example, by the yields convergence of European government bonds prior to the crisis; and secondly, how poorly many European banks were capitalised so that they were not able to deal with a decline in the value of their supposedly safe assets.
Since these problems appeared they were never tackled but they have only been shifted into the future. ‘Bad banks’ were formed to separate toxic papers from the core of the banks’ businesses. This was a quick fix but not a permanent solution as it is still unclear what will ultimately happen to these troubled assets.
In the eurozone crisis banks were given more help to stay afloat. They were allowed to use poorly rated government bonds as collateral in their dealings with the ECB so they could covertly divest themselves of their riskiest investments. Then, just last month, they could tap the ECB for unlimited liquidity for an unprecedented period of three years at a super-generous interest rate of 1 per cent. Banks seized the opportunity to soak up roughly half a trillion euros in total. Again, this helped stabilise the banks for the moment – but nobody knows what will happen in three years’ time when the money is supposed to flow back to the ECB. The banks are working on a wing and a prayer – and on borrowed time. Quite literally.
In all their emergency programs for the banks the vague hope of policymakers and central bankers was always the same. By the time the measures run out, so they wish, markets would have calmed down so that any temporary measure can be wound back without causing upsets.
It is the same optimistic assumption politicians made about Greece. By showering the country with bailout packages and economic reform mandates they hope that Greece will manage a sustainable recovery so that in the end the bailouts are no longer needed.
There is a problem with this wishful thinking: What if it turns out that Greece does not manage to return to capital markets because its economy remains on a downward slope and its debt-to-GDP burden keeps spiralling out of control? What if the massive amounts of liquidity do not solve the banking system’s underlying solvency issues?
If the policies taken towards bankrupt banks and governments do not work as intended, it will become apparent that they were really just holding off disaster without averting it. They just bought time. But the price for the time bought would have to be paid regardless.
Early on in the crisis radical solutions might have worked well. Instead of keeping the Greek government artificially alive and in the eurozone, they could have made the country default and exit from monetary union in early 2010, as Angela Merkel initially favoured. At that stage, the fallout could have been contained because the crisis had not yet spread to other economies. For such actions it is now too late. As we saw in last week’s S&P downgrade round, the Greek virus has now even spread to France and Austria.
The same is true for Europe’s banks. Earlier and tougher actions might have separated the sick from the healthier (or less sickish) banks. Instead, through their silly stress tests, the Europeans pretended for too long that the problems were manageable and could be contained easily. Soaring overnight deposits with the ECB now show that this did not restore confidence as banks do not trust each other anymore.
What’s left from all these botched emergency measures is no lasting solutions, only lasting costs. According to Professor Hans-Werner Sinn, president of Munich’s Ifo research institute, all eurozone rescue initiatives so far are adding up to almost €2 trillion for bailouts and guarantees. This is the price for four years of bought time.
Europe has run out of easy solutions to its many simultaneous crises. When it runs out of money to even buy itself more time to gloss over the symptoms of a dysfunctional monetary union, perhaps European leaders will finally start tackling the underlying problems. Time has become unaffordable.