There is much to reflect on following the decisions taken over the last weekend. The most important ones are:
- Policymakers have finally woken up to the scale of the problem;
- They still do not realize that promises are not enough;
- The instruments of fiscal discipline have been blown apart.
Barely a month ago European policymakers were talking of €30 billion as a huge show of “solidarity” towards crisis-stricken Greece. That got the financial markets to become even more worried about the euro. Then they came up with €110 billion for Greece. They had a strong conviction that the crisis had been ring-fenced and that there would be no contagion. That was a respectable amount for Greece, but not up to the task as far as contagion was concerned. Pledging €750 billion gets us closer to the kind of game that markets play. One can only admire the sharp learning curve of European policymakers, unless one wonders why they had to start from so far behind the curve.
The fund is an empty shell
This feat would be more impressive if the money was indeed available. Unfortunately, so far at least, it is an empty shell. It is surprising that the financial markets bought into it but then they did initially buy into several previous plans only slowly realize that the facts were short of the promises.
The bulk of the new plan is €440 billion of credit guarantees to be extended to debt instruments that run afoul of the markets. Somehow, someone will have the right of committing European taxpayers to support European public debts.
The problem is that there is no such thing as a European public debt or as a European taxpayer. This means that we must build an institution that will create both.
It will be very, very tricky to build an institution in charge of an amount of money about three times as much as the annual EU Commission budget. It will be even trickier to have countries whose deficits and debts have reached historical highs – that is practically all the EU countries – borrow even more to support each other.
The rest of the plan includes €60 billion to be borrowed by the Commission, about half of its annual budget, and €250 billion from the IMF. Problem is that the IMF does not lend money freely; countries must first apply for a program and negotiate conditions, as Greece did.
The unavoidable conclusion is that the money is announced but not available. How long will it take the markets to recognize this? When they do, they may do to Portugal and Spain what they did to Greece.
Finally, the long term consequences of all of this are nothing short of historical. The creation of the euro was an extraordinarily bold undertaking because member countries were to remain fully sovereign as far as budgetary matters are concerned. It was clear that the monetary union would not deliver price stability unless fiscal discipline was guaranteed. No less than three safeguards were built in the Maastricht Treaty.
- The no-bailout clause established that countries being sole in charge of their budget would have be sole responsible for any slippage.
This gave rise to the no-bailout clause, which prevents any European government or official institution from rescuing another government.
- The ECB was barred from financing public debts.
- The excessive deficit procedure led to the Stability and Growth Pact.
The Pact never worked. The remaining two safeguards have been blown away.
The Greek package had already hammered the last a nail into the no-bailout-clause’s coffin. The promised €750 billion plan spectacularly confirms that policymakers have decided to ignore the clause.
The ECB decision, announced on Monday, to buy troubled government bonds directly links monetary policy to undisciplined fiscal policies. To be sure, the ECB has pledged to sterilize its troubled bond purchases, i.e. to mop up the money that it creates to buy the bonds by selling other assets, possibly by issuing its own debt.
This is totally unconvincing. In effect, the ECB is bailing out governments. The ECB has spent its first ten years of existence berating fiscal indiscipline – even small lapses - and reaffirming its commitment never to buy public debts, the ECB has just turned around 180 degrees. The most troubling aspect is that this move is clearly part of the overall package. One can interpret it as emergency efforts to avoid another Lehman-style collapse. Alternatively, one could conclude that the ECB’s famed independence has not survived its first test.
The saddest part of all this is that crucial principles have been sacrificed for the sake of unconvincing announcements. The debt crisis is unlikely to go away and the monetary union will have to be reconstructed to re-establish the principle of collective fiscal discipline.