When the Modest Proposal argued, a year ago, in favour of a debt management system, for the eurozone as a whole, with the ECB at its centre, the general response was that it was a good idea containing a major flaw: the suggestion that the ECB issues its own eurobonds (for the purposes of financing the servicing of the eurozone’s Maastricht compliant debt). The rejoinder was that this is not what Central Banks do. It is my feeling that our answer to this objection was complete and comprehensive. Indeed, it seems to be winning the argument across different schools of thought. Today I want to go a step further: To argue that the ECB must issue its own eurobonds for its own sake, in order that is to retain its credibility and independence.
To make this point succinctly compare and contrast the current trials and tribulations of Mr Bernanke and Mr Trichet.
When Bernanke decided that QE2 was the way to go last year, in view of the US’ anaemic growth performance (or indeed if he now wants to embark upon QE3 in the face of the Great Recession’s impending second dip), the requirement for the policy’s implementation is straightforward: a majority of the Fed’s board must vote in favour. Suppose for instance that he musters the necessary majority even though the governor of the New York Federal Reserve disagrees. Though Bernanke would much rather such disagreement did not prevail, he is nevertheless at liberty to pursue with full vigour his chosen policy once he gets his board to back it.
Imagine, for argument’s sake, that the State of New York were not just another state in the Federation but that it had full control of all taxes (including income tax) generated within the State and, moreover, that these taxes were essential in propping up, at the discretion of the Governor of the State of New York, a large number of insolvent states (e.g. Ohio, Illinois etc.). Finally, suppose that the relationship between the Governor of the State of New York and the governor of the New York Federal Reserve were close, not only personally and politically but also culturally, linguistically, historically etc. I submit to you that Mr Bernanke’s, and the Federal Reserve System’s independence, would be greatly circumscribed.
This is of course Mr Trichet’s predicament. As we speak, he has embarked upon this desperate program of purchasing Italian and Spanish bonds in the secondary markets against strong opposition from one of the European System of Central Banks’ constituent parts: the Bundesbank – the Central Bank of the country that is financing the EFSF and all the bailouts and which, it is common knowledge, is the only thing that prevents the euro system, and thus the ECB, itself from biting the dust today.
The point here is that the ECB’s supposed independence increasingly means nothing at all. Its Germanic remit, to concentrate exclusively on price stability as the Bundesbank once did (without, that is, any concern for growth and employment – the Fed’s second pivotal remit), means that the ECB does not have the legal standing to pursue quantitative easing in order to arrest the catastrophic pessimism engulfing the eurozone. And now that this pessimism is contributing generously to the demise of Italy (the main problem of which is stagnating growth), Mr Trichet finds himself in the impossible situation where he must buy up Italian bonds just to keep his own ship above water.
Alas, the markets know that he is doing this in opposition to the Bundesbank. In other words, markets know damn well that Mr Trichet will never be able to buy anything near the quantity of Italian bonds that are necessary to make a medium term difference to Italy’s fate. So, they will soon (after many market participants take advantage of the ECB’s purchase program to unload what Italian and Spanish bonds they can) start attacking Italy’s bonds. In short, unlike Mr Bernanke, Mr Trichet’s battle was lost before it was even conjured up. Nothing hurts a Central Bank’s credibility than the common knowledge that it is fighting a losing battle.
Locked in this conundrum, Mr Trichet can kick and scream all he likes that this is a mess that the politicians should sort out, not the ECB. But he should know better by now. Judging by the last eighteen months of incessant dithering and the latest fudge of the second Greek ‘bailout’, politicians are clearly not in a hurry to create a systemic solution for this systemic crisis. They will, when pushed, say many of the right things but when it comes to implementation they will continue to cling on to toxic practices (e.g. the EFSF’s funding structure) and to delay anything that may actually cost real money (as opposed to guarantees). In short, Europe’s politicians have taken Mr Trichet to the cleaners and have, since, put him out to dry.
With his independence in dealing with the Italian and Spanish fallout circumscribed by the Bundesbank’s recalcitrance, and his credibility in tatters as a result of fighting a losing battle, Mr Trichet has an opportunity to leave the ECB with a move that will restore his reputation: Set in train the issue of eurobonds for the purposes of financing, initially, the current program of purchasing Italian and Spanish debt in the secondary markets.
With such a move, the ECB will have killed two birds with one stone. It will no longer be in thrall of the Bundesbank and the German government, as it will have its own means of utilising non-European official and global private funds for the purpose of financing policies essential to the long term survival (let alone stability) of its charge (the euro). And, to boot, it will have given the politicians a way out of their current cul-de-sac (i.e. the toxic EFSF): The moment the ECB can fund, by its own means, the servicing of the Maastricht compliant eurozone-wide debt (60% of each eurozone member state’s debt) politicians will, no doubt, see the light and turn away from the doomed EFSF-based strategy to implementing Policy 1 of the Modest Proposal.
This is what we have come to: Our European Central Bank must, to preserve its dignity, credibility and independence, take a bold move to borrow in the international markets in order to stabilise the currency and show Europe’s pathetic politicians the path that leads to salvation.