Time to put the doomed euro out of its misery
Europe can’t accept that the economics of the single currency condemn it to failure.
By Jeremy Warner
12 Apr 2012
There is no mess quite so bad that official intervention won’t make it even worse. Nowhere is this old saw more applicable than in the eurozone, where only a month or so back, leaders were warmly congratulating themselves on having seen off the worst of the debt crisis. As is apparent from the events of the past week, these hopes were not just premature, but naive. The crisis is once again intensifying, with the focus of attention switching from Greece to Spain.
The European Central Bank’s flooding of the banking system with cheap money didn’t solve the problem, or provide more than short-term relief for its symptoms. After a brief period of remission, they are returning. At best, the ECB bought a little time. This has not been used well. Instead, the eurozone has just ploughed on with the same old set of failed policies.
The Spanish government, for example, recently announced 29 billion euros of spending cuts and tax increases. It failed to do the trick, so this week a further 10 billion was added to the tally. This only succeeded in unnerving the markets even more, forcing the ECB to concede that it might have to engage in further purchases of Spanish government bonds.
By promising virtually unlimited liquidity, the ECB may have prevented a Lehman-style meltdown of the banking system. Yet it also accentuated the underlying problem. Virtually free central bank finance has enabled Spanish and Italian banks to engage in a highly profitable arbitrage, borrowing money from the ECB and then reinvesting it in government bonds. This, in turn, helped ease the fiscal travails of the European periphery. But it also increased the banks’ underlying solvency problem, since they have been buying bonds that may eventually have to take a haircut.
Already, many are facing losses on their purchases. Yields have been rising again, as investors worry about the sustainability of Spain’s debts. What’s more, the preferential treatment given to the ECB and other “official” purchasers has concentrated the risk of default among the remaining investors, acting as a further deterrent to holding sovereign debt.