Bill Totten's Weblog

Thursday, May 13, 2010

ECB must share blame for Greece's excesses

by Richard A Werner

The Daily Yomiuri (May 08 2010)

What is happening in "Greece is not the crisis of a country, but a fundamental question for Europe and the euro", said Martin Blessing, Commerzbank's board chairman of managing directors, at a conference in Munich on April 29.

His answer to this fundamental question is: Europe must either move toward political unification while underwriting Greek debts or "shrink the currency union". Either create a United States of Europe, or kick Greece out from the euro.

The Greek crisis has indeed raised fundamental questions for Europe and the euro. These questions were predictable and have in fact been predicted by euro-skeptics. So Europeans should not let their options be limited by those who got us into this mess in the first place. There are better ways forward for Europe and Greece.

If for whatever reason one decided to bail out Greece, one should opt for the most efficient and least costly method. This would be for the European Central Bank's Greek branch (aka the Bank of Greece) to purchase Greek government bonds.

Although one would expect the ECB to act as the main defender of the euro, instead the far more expensive and wasteful method has been chosen of getting the German government, together with the other unlucky members of the eurozone (EU members Sweden, Denmark and Britain get off scot-free) to buy Greek bonds.

Since the German government does not have the spare fiscal surplus to buy Greek bonds, and, unlike the ECB, is not allowed to create money at zero cost, it will have to borrow the money - by issuing more German government bonds.

So the Greek debt adds to German debt, as well as the debt of Spain, Portugal and Ireland. It carries a compounding interest burden that will drain resources from generations of taxpayers and could, should interest rates rise sharply, cause a debt crisis in the other eurozone countries, even in Germany. It also creates the wrong incentives, as the fiscally more virtuous pay for those in greater debt.

But for Germany to lend more money to Greece is also bad for Greece: Like the loan sharks offering to "help" overindebted "subprime" borrowers by burdening them with even larger debt, any such deal as now being decided by the European Union and the International Monetary Fund will merely increase Greece's total debt.

Would it not be better for Greece to exit the eurozone? No doubt, Greece should not have joined in the first place. And this applies not only to Greece, but to all member countries: by joining, governments gave up the most powerful economic policy tool available, namely monetary policy.

If Greece still had its own currency, it would have far more attractive policy options at its disposal. That's why I strongly advised against the adoption of the euro. As I wrote in the Financial Times in the mid-1990s, the economics of euro introduction did not make sense: Europe already had a currency, and that was the deutschemark.

This did not seem to bother the euro-supporters, as they were pushing a political agenda. But the political logic has been just as flawed: the idea that European countries would wage war against each other if a single currency was not introduced was political scare-mongering by a bureaucratic elite bent on concentrating all powers in their hands without democratic accountability.

In the years and months before the Swedish referendum on whether to join the euro in 2003, I gave speeches in Sweden, including at the parliament, and published a book in Swedish. I made a heartfelt plea for the country - lucky enough to have avoided the euro until then - to keep its currency. Swedes were also lucky to even get to vote in a referendum - no such luck for the people of France or Germany. (And Swedes were smart enough to vote "No" despite the predictable threats uttered by its political elites: if Sweden did not join, Swedes were told, the country would "drop out" of Europe" - presumably by force of a massive geophysical-tectonic upheaval.)

Today, more people are waking up to the reality of what those governments who joined the euro did, namely give up the most important sovereign right and most powerful economic policy tool - that of monetary policy and the issuance of national currencies.

Once the currency has been given up, all other governmental powers, such as taxation, regulation and fiscal expenditure, would ultimately be forced to be aligned with the euro monetary system - instead of the monetary system catering for each country's economic and political needs.

If Greece stays in the eurozone, it cannot devalue its currency, and all adjustment costs would be forced onto businesses and labor - meaning lower wages and higher unemployment in the years to come.

So when Greece joined the eurozone, it delegated monetary policy to the ECB. This has left Greece without monetary policy. But it does not mean that there was no monetary policy. Quite the contrary, the ECB has for most years since its creation pursued a policy to encourage governments in the southwestern periphery, especially Greece, Ireland, Spain and Portugal, to make unrealistically high revenue growth (and hence spending) projections. It did this by its perennial - though little-known - policy to boost commercial bank credit growth in these countries at an unsustainably fast pace in the double-digits (at times even exceeding twenty percent annual growth in these countries).

Bank credit is primarily determined by central bank policy. Stoking this massive credit bubble in Europe's periphery - like a "ring of fire" - has been the ECB's clandestine regional policy. Bank credit growth means money supply growth.

While in public the ECB would emphasize its interest rate policy - which is identical across the eurozone - unknown to the public, the ECB implemented regionally diverse credit growth policies: boom in the periphery, with banks encouraged to print money as if there was no tomorrow, and bust in Germany, where bank credit was almost entirely shut down, causing weak growth and rising unemployment. It is this ECB policy that is now coming back to haunt us.

Thus Greece is not solely to be blamed for its crisis. The institution it had entrusted monetary policy to, the ECB, also must share responsibility, for it was the ECB that created the unsustainable economic boom that encouraged an overoptimistic fiscal stance. It was also this ECB policy that rendered the Greek banking system fragile to the effects of the financial crisis, and this also added to the fiscal burden on Greece.

Why did the ECB adopt such irresponsible and regionally diverse credit policies? We have to ask them - though ECB staff tend to remain silent on this issue.

When I asked ECB President Jean-Claude Trichet at Davos in 2003 about this regionally diverse credit creation policy, he merely replied: "I don't know what you mean with 'credit creation'. We use interest rates as our policy tool." Perhaps he has read up on the role of bank credit in the meantime - but so far he has been keeping his insights from us.

Perhaps the ECB had originally calculated - with flawless central bankers' logic - that creating a crisis in this way would eventually force European leaders to rush into otherwise unthinkable political unification and the creation of a United States of Europe. But there are far better options available. They will be discussed in my article to be published next week.


Werner is the chair in international banking at the School of Management, and director of the Centre for Banking, Finance and Sustainable Development.

(c) The Yomiuri Shimbun.

Bill Totten


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