“By assuming the role of lender of last resort for highly indebted member states, the bank (ECB) would shed doubt on the legitimacy of its independence. To follow this path would be like drinking seawater to quench a thirst.”
Jens Weidmann, President of the German Bundesbank
There is yet another Euro Summit on Dec 9th. Will this be the one where Germany finally blinks? The European Debt Crisis has taken a new and dangerous turn. Bond yields in Italy and Spain have been rising for months but now France, Belgium and even Austria and Germany are being dragged into the mire. For all Angela Merkel’s rhetoric, only the European Central Bank (ECB) can ride to the rescue. Europe is now faced with two choices.
1. A break up of the euro zone. This would result in financial armageddon and a total breakdown of the world’s payment system. Not good, and hence not likely.
2. The ECB announces that it will act as lender of last resort, and stands willing and able to buy an unlimited quantity of European government bonds.
As the toughest guy in town, Germany gets to decide whether option (i) or (ii) occurs. French President Nicholas Sarkozy is on bended knee begging Germany to pick (ii). However neither scenario is particularly palatable for the German people as stories of hyper-inflation during the Weimar regime in the 1920s are legend. Yet faced with a bit of inflation or a lot of depression, it’s not that tough a choice.
So why does every German politician continue to trot out the line that the ECB will never backstop the Med countries and that a fiscal union is unacceptable? The answer is that Germany is playing an elaborate but risky game of poker. Germany wants a commitment from the other European governments that they will finally get their finances in order. It also wants to be able to impose real penalties on those countries that refuse.
Its track record in November is impressive. It has already replaced democratically elected governments in Greece and Italy with individuals who have never faced an electorate. This is real power in action.
We believe that Merkel will blink. The markets will soar on any announcement that the ECB will stand behind Italy and Spain. However this won’t be the end of the euro story. It will buy a lot of time but unless Europe can shed its entitlement culture, it will not be out of the headlines for long.
“The troubles in European countries are purely because of the worn out welfare society. I think the labour laws are outdated. They induce sloth and indolence rather than hardworking. The incentive system is totally out of whack.”
A view from a free market capitalist extremist? No. These are the words of Jin Liqun, the Chairman of China Investment Corporation, China’s sovereign wealth fund. How times change.
Disaster can be averted. With the ECB as lender of last resort, interest rates cut to zero, a fall in the euro to parity with the $$, co-ordinated Central Bank action (as seen this week), tax cuts in the core and austerity in the periphery, nationalisation of the weaker banks and recapitalisation of the stronger banks, Europe might just muddle through.
