Dredging for the Euro
November 11, 2011Posted by on
My post with the title ‘Euro spivs?‘ condensed an article by Marshall Auerback writing on the blogspot New economic Perspectives in which he claimed that the markets are again in free-fall. While Auerback clearly intended to name Mario Draghi as the bête noire of his article, Draghi is perhaps a bit player in it. The article is really in two parts; in Euro spivs? Aureback is critical of the democratic deficit within the EU, specifically with regard to the Franco German handling of the economic crisis facing the euro in forcing fiscal austerity on Eurozone members. In this the second part of Auerback’s article, he expresses the view that such fiscal austerity is counterproductive, especially for Italy, while offering a fiscal Keynesian solution. Needless to say, Mario Draghi, the chairman of the European Central Bank (ECB) remains a figure in this.
Auerback states that unlike Greece, Italy runs a primary fiscal surplus with its fiscal deficit to GDP ratio at 60% of the OECD average (less than the euro area average). Its ratio of non-financial private debt to GDP is very low relative to other OECD economies. It has a vibrant tradeable goods sector selling things the rest of the world wants. Introducing austerity at this juncture will cause even slower economic growth and higher public debt, creating the national insolvency crisis that Europe seeks to avoid, with the crisis moving to France, and ultimately to Germany being inevitable. With the entire euro zone in severe recession the ECB, the Germans, the French and virtually every single policy maker in the core continue to advocate ongoing fiscal austerity and yet the public deficits continue to grow.
In the 1990s, a number of countries, including Italy, engaged in transactions to secure entry into the euro (PDF), which had no economic justification other than to mask their public debt levels. Italy actively exploited ambiguity in accounting rules for swap transactions in order to mislead EU institutions, other EU national governments, and its own public as to the true size of its budget deficit. Yet Eurostat signed off on these transactions, adding that it’s perhaps ‘Karmic justice’ that Mario Draghi, who was director general of the Italian Treasury from 1991-2001 when all this was going on,now has to deal with the outcome as the new head of the European Central Bank (ECB).
Auerback claims that the solution is being avoided by the eurozone’s chief policy makers by not utilizing the European Central Bank (ECB) which has the capacity to create unlimited euros, and therefore provide the only credible backstop to markets that query the solvency of individual nation states within the euro zone. They should, as Professor Paul de Grauwe suggests in his article European Summits in Ivory Towers, be using the economic power of the ECB as the the monopoly supplier of currency. Capitulating to the markets, or entering them half-heartedly not only ensures more economic collateral damage, but effectively emboldens euro-zone speculators.
The notion that the ECB cannot act as lender of last resort is disingenuous: it has a “financial stability mandate” provided under the Treaty of Maastricht. Despite any ambiguity in the Treaty of Maastricht, Article 11 of Protocol on the Statute of the European System of Central Banks (ESCB) and of the European Central Bank (ECB), the institutional policy framework within which the euro has been introduced and operates, has several key elements.
One notable feature of the operation of the ESCB is the apparent absence of the lender of last resort facility, which Draghi uses to justify his inaction. But this is not clear-cut: The Protocols under which the ECB is established enables, but does not require, the ECB to act as a lender of last resort. Proof that the ECB exploits these ambiguities when it suits them is evident in its bond buying program. The ECB articles say it cannot buy government bonds in the primary market. A rule once used as an excuse not to backstop national government bonds at all, which changed in 2010, when it began to buy them in the secondary market.
The ECB also has a mandate to maintain financial stability and is buying government bonds in the secondary market under that mandate. Something that it could arguably continue to do. While there is disagreement about this within the ECB, especially within the legal department, this suggests that it’s politics driving Italy (and soon France) toward the brink. Quoting Warren Mosler Auerback says that:
Given the 50% “voluntary” haircut imposed on holders of Greek debt, arguably the ECB is the only entity that can now buy these national government bonds.
As it is hard to see how anyone with fiduciary responsibility can buy Italian debt or any other member nation debt after EU officials announced the plan for 50% haircuts on Greek bonds held by the private sector.
While all governments have the authority, one way or another, to confiscate an investors funds, they don’t and work to establish credibility that they won’t.
But now that the EU has actually announced they are going to do it, as a fiduciary you’d have to be a fool to support investing any client funds in any member nation debt.
The last buyer standing is and was always to be the ECB, which will now be buying most all new member nation debt as there is no alternative that includes survival of the union.
And when this happens there will be a massive relief response, as the solvency issue will be behind them, with the euro firming as well.