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The
ECB is under great pressure from all sides to rescue Euroland’s sovereign debtors with a round of
quantitative easing. Such
a solution is totally against the principals and
charter of the central bank, and has so far been resisted, the ECB only buying debt
in the secondary market
to lower the apparent cost
of funding for stricken governments. This is little more than a sop, because no investor in their right mind would buy
government debt at a price artificially
inflated by ECB purchases.
And nor should the ECB
support banks that
continue to buy bonds issued
by insolvent governments.
The clamour
for QE is entirely Keynesian. The simple answer is that indebted
governments must cut their spending, and hard. By doing so, much
needed economic resources will stay in their private sectors, which can lead to a surprisingly rapid recovery: look at Iceland, which was forced by reality to bite
the bullet and whose economy is already
recovering. But this
simple answer does not
fit into Keynesian ideals, which merely dismiss the private sector as having lost its
animal spirits, and therefore, they
argue, it is the duty of the public sector to take charge.
It was
hair-brained Keynesian economics and socialism that got Europe into this mess in the first
place, and this should weigh on the realists at the ECB in their deliberations. They now have the practical task of keeping the banking system intact. They cannot finance, or even
part-finance, Euroland’s government
deficits as well.
Just underwriting Euroland’s
banks might require up to a trillion euros, which
is inflationary enough; pumping money into insolvent governments ad infinitum will involve considerably more.
These governments are looking for a soft touch: they have found it in the European Financial Stability Fund, but that is too
small for their continuing negative cash-flow.
The Chinese, after expressing initial interest just to annoy the Americans, have backed off. The
PIIGS are now offering their begging-bowls to the ECB.
However, printing money for governments
to spend is the high road to hyperinflation. The ECB are therefore likely to say no, to the disappointment
of Keynesians and socialists
alike.
If the ECB does refuse to subscribe for
new government paper, the
PIIGS governments will at last be forced
to face up to the reality of their financial position. And who
knows, if one of them gets real, the others might follow. Keynesians everywhere will probably advise them to leave the euro in favour of their old softer
money. This is like advice to a chess player from someone
who can barely think one move ahead, because it would leave
liabilities in hard euros, and future funding in a collapsing drachma, punt, lira, peseta or whatever.
While exiting the euro would rapidly force a default
on any of the PIIGS ejected
from the sty, it would also
offer the prospect of hyperinflation for the ejected, and the position of Euroland’s
banks would probably be worse
than if they stayed.
By dealing
with the European banking crisis in this way, the ECB will then be
able to tackle the separate
issue of exchange rate policy, which
is another problem lurking in the
background. With the world on a dollar-standard and
the Fed printing money with gay abandon, the euro will continue to be strong. This will intensify political pressures
on the ECB from all Euroland governments,
worried about terms of trade. That is a totally separate issue and should not be confused with the immediate problem.
The ECB’s
decision in this matter will be
for the markets a decisive
indication of the course of future euro inflation.
Alasdair
McLeod
Essay originally published on www.goldmoney.com
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