26 September 2011

Stability Facility Two-Step Reaches Conclusion

After weeks of rising political rhetoric the outline of a plan for the Eurozone appears to be emerging. The road that involved further debt guarantees from the wealthier nations of the EU, primarily Germany, and a consolidation of all Eurozone debts into one Eurobond, appears to have been abandoned. This was presumably because Chancellor Merkel refused, or argued successfully that this was politically impossible and might lead to a less market-friendly government in her country—perhaps even a Green one.

Since the debts cannot be absorbed the new plan is that some will be turned into losses, with a negotiation between the banks that unwisely took on Greek bonds and the Greek government that cannot repay them: the so-called hair-cut, which is now moving down to a number 2 on that automatic machine that muscular men with early hair loss so often favour. It was the Argentinians back in 2002 who taught us that it takes two to tango: serious debt crises require losses to creditors as well as pain to debtors.

The other side of the plan is more interesting: a larger bailout pot, now tastefully renamed the European Fiscal Stability Facility. This will be available to support governments whose national debt is so large as to undermine market confidence. It is assumed that it will never be used: its existence is intended to be enough to underpin confidence. This means it will have to be a very large pot indeed. And once the money is in the pot you can guarantee that the financial market makes will find some way to provoke a crisis and make it their own.

The argument now seems to be about where the money will come from to fill the pot. We must keep very close attention on this. If the money comes from national governments then our obvious question should be: 'How can there be money to put into a bailout pot when there is no money to pay for hospitals or children's services?' If, alternatively, the money is created directly by central banks—in a process akin to quantitative easing—then our question should be: 'Why not create enough money this way to repay all the national debt and so remove the need for the pain of spending cuts?'

This is the most interesting question of all. We know that the Bank of England is under pressure to quease more money into the economy at any time. Some of that money has previously been spent buying back our own debt; a similar process has been undertaken by the European Central Bank to buy Italian debt. So why not go the whole hog? Could it be that this would make it clear that there really is no need to create money as debt in the first place? That money could be directly spent into the economy as needed. The reason for resisting this is the power of those who live by lending money: without debt they would have to go to work like the rest of us.

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