Germany and other AAA rated eurozone members could have bailed out Greece for as little as €200bn if they had acted quicker and ignored "moral hazard" principles, says Francis Scotland, director Global Macro Research at Brandywine, a subsidiary of Legg Mason.
A Cure Worse Than The Disease?
On October 3, 2010 Germany made its final reparation payment for World War I on its outstanding debt incurred under the 1919 Versailles Treaty. Germany takes its debt obligations seriously and expects others in the euro zone to do so as well.
Much has been made of Germany’s use of the current crisis as a tool to force budgetary compliance on the fiscal delinquents of the union and to accelerate a closer fiscal union in return for more support later. If you believe this version of events, the non-compliant members of the union were clearly the ones to swerve in this high-stakes game of chicken. Governments in Greece and Italy have dissolved and been replaced with technocratic regimes. For all the hand-wringing about a potential splintering of Europe, the drive to hold it together is impressive. The reason is money; the costs of it falling apart are incomprehensible.
It’s not hard to see how the recent proposal to fast-track some sort of fiscal union could be the first step to a collectively backed European debt market. At the very least, Europe could collectively back a portion of each country’s debt-up to the first 60% of each country’s GDP, for instance. But the sequencing is crucial as many European leaders have pointed out and the German authorities are in no rush to offer any carrots.
It is going to take a lot more to bring investors back to European sovereign credit than some sort of fiscal pact, no matter how accountable. Fiscal austerity increases downside risks to the economy which only makes public-sector gearing even worse. Excess private-sector debt can be cleared through bankruptcy. Public debt is cleared through economic growth, default, or monetization. Austerity without counter-cyclical stimulus increases the risk of deflation.
The lesson from the Great Depression is that monetary policy should devalue the home currency against the international monetary standard in order to avoid a debt deflation. The ECB sat on the sidelines for most of 2011 limited in its response for legal reasons and by a sticky inflation rate. However, the acceleration of the credit contraction, the shortage of liquidity in the final quarter of 2011 and possibly the fiscal developments in Italy finally prompted the central bank to provide unlimited lending to banks and to expand the range of assets it will accept as collateral. As a result, the central bank’s balance sheet has mushroomed.