Friday, 9 December 2011

Is the ECB Intent on Replacing Euro Hara-Kiri by Euthanasia?

Another useless EU Summit - thank you Mr. Cameron for killing the new “Merkozy” version of an absurd fiscal union for the entire EU. This time, the absurdity of setting a budget limit of 0.5% of GDP (when it has been unable to comply with the existing limit of 3%), was compounded by requiring its inscription as a rule in national legal systems at constitutional or equivalent level (see here why this is a mistake).

Let us now hope that a referendum in Ireland or any other country will kill the alternative proposal for a fiscal union among Euro Zone members through a new "fiscal compact". As we said here, a fiscal union between Germany and France may make sense but it would be a disaster for the entire Euro Zone.

The potential collapse of the Euro Zone will not be due to a fiscal problem in the Euro Area; which does not exist, despite the fact that three smaller members have excessive debt and Germany has an excessive current account surplus. The problem resides in the ECB’s refusal to act to stop the speculation against the Euro by invoking that its charter does not allow for the monetization of fiscal deficits.

Mr. Draghi is either naïve or wants us to believe in fairy tales. During his last press conference, he said that funding the IMF to finance exclusively the Euro Zone governments would be against the ECB charter. However, the ECB practice of accepting modern day versions of accommodation bills, in the form of bank drafts and bonds issued and subscribed by the same bank with a government guarantee and used to purchase the debt of the said government, is a more dangerous form of debt monetization since it lacks any kind of conditionality. Moreover, it puts those governments in the position of sitting ducks for speculative attacks.

As we said before bank-to-bank loans with strong conditionality are preferable. Obviously, we do not advocate that the ECB should negotiate or monitor such conditionality. Specialized institutions such as the IMF or the EFSF/ESM should do that.

Unfortunately, as we said repeatedly and the experience of Greece, Ireland and Portugal shows the IMF adjustment policies for monetary unions are seriously flawed.

Yet the ECB did not demand from the European Council that the ESM should take its place. Instead, the Council decided that all EU member states would lend to the IMF an extra 200 million Euros in the hope that non-EU countries might do the same.

In summary, by accepting the self-inflicted fiscal Darwinism of Germany that will lead to expelling peripheral countries from the Euro Zone, despite a half-baked mix of ECB and IMF support, will not restore confidence in the Euro. All it does is to replace the previous ECB hara-kiri intent with a slow euthanasia carried out by an IMF firing squad.

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