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|Firewalls won´t help Europe avoid the iceberg|
The Times - October 10th 2011
Forget the Black Death. Forget, too, the South Sea Bubble of 1720, the Baring crisis of 1890 and even the Great Depression of the 1930s. According to Sir Mervyn King, governor of the Bank of England, we may be in the worst financial crisis ever. Angela Merkel,
Well, it could, though not such as to justify Sir Mervyn’s hyperbole. Central bankers are normally taciturn and under-stated. That he chose to be the opposite might mean that he knows of some forthcoming horrors that we don’t, but more probably he was stretching a point to justify his announcement of a new round of money-printing (aka “quantitative easing”, by buying a further £75 billion-worth of gilts), given that inflation remains well above the Bank’s mandated 2% target.
The new policy looks right, even if the argument used for it risked being counter-productive. Britain’s economy has been stagnant for the past nine months, there is no prospect of tax cuts or other fiscal stimuli, and our main export markets—Europe—are indeed staring into an abyss. With oil prices 25% down from their peak in the spring, unemployment high and pay being frozen, the danger of deflation is now higher than that of inflation. Monetary stimulus is the only option in response, although in today’s depressed conditions it is no panacea, either.
There are, as this columnist pointed out on August 22nd, bright spots in the world’s economic picture that will provide Britain and Europe with some support: Japan is rebounding from its post-tsunami slump, America is still crawling forwards, and the Asian emerging giants are growing lustily despite a modest slow-down from their inflationary double-digit growth rates. Yet that would all just be nice tunes from the Titanic’s orchestra if the euro were to hit an iceberg.
So will it? Iceberg-avoidance was the purpose of yesterday’s meeting between Mrs Merkel and Mr Sarkozy. It will also be the purpose of a series of policy moves that will be made by euro-zone governments during the next few weeks, which will be about injecting new capital into banks, adding firepower to the euro’s rescue fund, and dealing with
The difficulty will lie in judging whether these moves will be enough to prevent slow European growth turning into a new slump, which is what a 2008-style financial collapse would bring. The only sure prediction is that Messrs Merkel, Sarkozy and others will declare this month or next that all problems have been solved and that a new dawn is breaking. So here is how to judge whether to believe them.
Essentially, Europe’s problem is that after the 2008 worldwide slump, private debts became turned into much larger public debts especially in the countries least able to afford them, the sclerotic, inflexible nations of southern
The cure that for the past year euro-zone members have been attempting, with help from the International Monetary Fund, has been to give the troubled debtors bridging loans at cheaper, official rates. This has bought time but has done nothing to deal with the underlying disease.
Meanwhile European “bank stress tests” which assumed that government bonds would cause no stress at all simply sapped policy-makers’ credibility, which was further sapped by divisions and dysfunctionality in Mr Berlusconi’s government, which presides over the euro’s third-largest economy and owes more than 1.6 trillion euros (£1.4 trillion)—a default on even part of which would bring European banks tumbling down.
To have a good chance of preventing other banks following
But if Germany does prevail, the national bank recapitalisations will need to be both large (preferably at least £300 billion) and co-ordinated, and will need to be backed by new stress tests that assume the sort of sovereign-debt write-offs that markets have been speculating upon, and then some. Only credible stress tests matched by really big capital injections will end the speculation and worry.
Such capital injections are not free lunches: they will add to the sovereign debt problem, at least in the short term. So the other test is about managing that sovereign debt. Everyone knows that
Yet then comes the task that has been holding everything up: working out how to make that announcement in such a way that it does not immediately imply that