So we wait to see whether the ECB is really willing to sit back and let the whole edifice collapse.
Are the Bundesbankers really so stubborn that they would rather bring down the European financial system, tank the world, and cause a deep global depression, rather than enter the bond market on sufficient scale to back-stop Italy and Spain?
Tough call. 50:50, I’d say.
The hardliners are seriously ideological people, and there seem to be some in the upper echelons of German policy-making (though obviously not the floundering bean-counter Schauble, or the battered Chancellor), who suspect that it might be better to lance the boil by forcing an immediate break-up of EMU.
I note that Belgium’s central bank Coene hinted that the ECB is withholding bond purchases to force Italy and Spain to push through – you guessed it – yet more growth-destroying austerity. Dangerous game. These 1930s deflationists really are a menace to society.
In a nutshell, unless the ECB is willing to step in – I mean really step in, not piss in the wind – until such a time as the revamped EFSF bail-out is ratified by all parliaments and is ready to take the baton (say November), and unless the EFSF itself is quadrupled in size and given to a €2 trillion mandate without all the German-imposed ifs and buts, then the game is up.
If the EU authorities refuse to do this, it is best for everybody that is recognized immediately and that arrangements are made for the orderly break-up of monetary union … not next year, or next month, but next week.
There are two basic choices: 1) a spiralling crisis in the South, leading to a string of countries being blown out of EMU, causing a catastrophic financial collapse akin to 1931.
As Citi’s William Buiter told me yesterday, the issue is not how long Italy and Spain can ride out the storm in bond markets. There would be a banking and insurance crisis long before sovereign defaults came into play simply because the fall in bond prices on the secondary market is causing carnage to bank books (among other transmission mechanisms).
Or 2) Germany and its satellite economies withdraw immediately from EMU (let us say the Netherlands, Austria, Finland, Flanders, and Luxembourg). This allows the South to enjoy a much-needed devaluation to restore competitiveness without going through a disastrous Fisherite debt deflation. Their contracts would remain in euros, so they would not need to default.
Temporary capital controls and some form of financial repression would obviously been needed for a few weeks. The German bloc would have to stand ready to recapitalize its banking system with €100bn perhaps (peanuts in the bigger picture) to offset the shock effect on sudden exchange losses on Club Med debt.
This would require French leadership. (I have almost given up on Germany). Carried out with Napoleonic speed and determination, I think this could conceivably prove the game-changer that halted the downward global spiral.
Markets would very quickly see that the greatest impediments to recovery had been removed. We could rejoice, and breathe little easier again. My guess is that stock markets would surge in Milan, Madrid, and Paris, as occurred in London and Milan after the ERM crisis in 1992.
Yes, I know, EMU is not the ERM, blah, blah, sanctity of the Project, blah, blah, blah.
But just how different is it really?
Will this happen? I don’t see much evidence that anybody is thinking along these lines. (The Buba men seem to want to expel Greece, Portugal, etc, which is not at all what I mean).
Just my instant thoughts on a story that is moving with lightning speed.
More later, after some Rioja, and a Vecchia Romagna to finish.
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