Published in Business Spectator (Melbourne), 8 March 2012
The eurozone crisis is a strange beast. When it suddenly erupts with ratings downgrades, spiking yields and high political drama it can scare even the most experienced analysts and commentators. But it is probably much more dangerous at times when the crisis has seemingly settled down.
We have seen this pattern before. After the first Greek bailout package and the establishment of the European Financial Stability Facility relative calm prevailed for a few months in the European summer of 2010.
The seeming loss of urgency put crisis management into effective hibernation, and the EU went back on autopilot.
We know what happened next: policymakers were woken up by fresh concerns about Ireland and Portugal, and so the crisis reached a new high. As it turned out then, the problems had only been put on hold by attaching sticking plasters to them.
In a similar fashion the latest crisis surge which started in July 2011 has calmed down for now, mainly because of the two rounds of ECB virtual money printing under the euphemistic heading ‘Longer-Term Refinancing Operation’. However, and if experience is anything to go by, this latest episode of tranquillity is just another calm before another storm.
Personally, I have drawn my own conclusions from the patterns of the eurozone crisis by devising my very own early warning system for trouble ahead. It is a very simple heuristic based on the weekly newsletter I receive from the chief economist of a European bank. Since he is a personal friend of mine, whom I got to know as a good liberal economist, I won’t name the bank he works for.
To begin with, his predictions have been consistently too optimistic throughout the crisis. So when he promises us a quick return to trend growth in the eurozone in his latest forecast, I believe it’s time to suggest to my European friends to start growing vegetables in their backyards and prepare for the worst. My eurozone worries are getting worse the more hopeful my chief economist friend sounds.
What I find even more fascinating, or rather disturbing, about his newsletter is the banking sector’s thinking about the EU’s crisis management that it reveals. It is a world view that obviously develops by working inside financial institutions for too long. Even staunch free market economists, who had always supported every product market liberalisation, each free trade initiative and any attempt to deregulate labour markets all of a sudden become firm believers in the power of the state when it affects their own interests.
And so every political folly throughout the eurozone crisis was greeted with enthusiastic praise in my friend’s weekly updates. The bigger the bailout packages the better; the more firepower behind EFSF, ESM, LTRO and all the other acronymised bazookas the more his newsletters became jubilant. Little wonder as all of these schemes helped to serve one goal: to keep financial institutions in Europe alive that, arguably, should have been liquidated a long time ago. And if it had not been about banks but about any other industry, I am almost certain that such a policy of cleansing the sector of poorly performing companies would have found his approval.
Conversely, the moments in the eurozone crisis when my banking friend was most upset with policymakers were the few instances in which I thought they had done something right.
So in his view, it was a crucial mistake to threaten investors with haircuts in their eurozone periphery investments, as had happened at the summit in July 2011. This had created far too much uncertainty, he argued.
Of course, from a banking perspective this is entirely understandable: High yields are great, but they are even better when they come with no risks attached. Now that the possibility of early haircuts (outside Greece) is effectively off the table, and after investors have dumped most of their Greek paper with the ECB anyway, he is reconciled with the EU once again.
Even when my economist friend writes about fiscal discipline and austerity it is hard to differentiate between impartial economic advice and naked self-interest. He supports measures like the new fiscal compact – probably because it will keep sovereigns solvent for longer, which incidentally is good if you hold government bonds issued by these countries. That such policies may become self-defeating when fiscal contraction cannot be accommodated by an external devaluation is never mentioned in his analyses.
If I wanted to caricature his views, he envisages an environment in which countries may keep limping on as long as they can service their high-yielding debt burdens. It is a world in which the task of banks is to use cheap and virtually unlimited liquidity, provided by complicit central banks, to buy risk-free government papers. Governments are cash cows for banks as they provide them with secure and effortless income, simply by paying interest on debt that they themselves guarantee. Should those guarantees not suffice, central bankers jump in with fresh money. And ordinary people as consumers and taxpayers pay the bill for this bonanza through higher inflation, taxes and debt.
As the eurozone crisis has now seemingly calmed down and my friend’s updates become more ecstatic by the week, I am afraid that we are edging ever closer towards his dream scenario. To most Europeans, bankers excepted, it may actually seem more like a nightmare.
To most liberal economists outside the financial sector it would probably look like that as well.