Political Equilibria

I have severe doubts about the latest “solution” to the Eurozone crisis, which can be simply summed up as unlimited ECB secondary market purchases of troubled sovereign debt provided the sovereign in question meets certain fiscal demands.  I should begin by saying that it looks to be much better than anything I’ve yet seen come out of the Eurozone leadership in an attempt to solve the crisis – the ECB can’t run out of money, and is thus the only actor with the funding to actually resolve the crisis without a debt default.  However, technical financial aspects aside – it fails to establish a plausible political mechanism for fiscal and monetary management of the Eurozone as a whole and of member countries.

Bluntly put, this is a breathtaking power grab by Mario Draghi.  His plan would install a central bank veto over national tax-and-spending decisions, with the power to send them into bankruptcy if they don’t obey.  If I were a Spaniard or Italian, I would find this abrogation of my democratic rights to be sufficient reason to strongly oppose this plan on principle alone (and they agree).  As an American with no direct stake in their democratic rights…I care mainly that they will care.  Especially since in addition to the Draghi veto, the plan also maintains the key weakness of every plan up until now – all Euro member states get veto power over budgets as well, since the Eurozone must approve a fiscal bailout before the ECB will step in to buy bonds.

I should stress that this struggle for power between fiscal and monetary authorities is not an inherent feature of the Eurozone.  If Ben Bernanke announced tomorrow that he wouldn’t step in to resolve a financial crisis unless Congress passed a budget he personally approved of, the same dynamic would apply.  Even suggesting the possibility in an American context demonstrates what a poisonous political dynamic is being created here.  The fact that the ECB is dominated by Northern European interests and the “troubled members” are mainly Southern doesn’t help, but it doesn’t create the dysfunction.  I would instead point to an ideological belief – the technocratic faith in balanced budgets as a solution to all problems, and an obsessive desire to avoid inflation in the core at all costs.  This is bound to create a serious conflict with the democratic process in Southern Europe.

The last and biggest problem is that Draghi’s leverage is not credible.  This is a really big deal – in order for the ECB to blackmail Spain and Italy’s governments, it must be universally believed that Spain and Italy are not too big to fail.  If either Spain or Italy’s populace decided to call his bluff in the interest of avoiding further contractionary spending cuts, would Draghi shoot the hostage?  I think not, especially given the immense economic harm it would inflict on Germany.  Furthermore, I think it is universally realized that Draghi would not shoot the hostage.

This is not the normal credibility problem that central banks struggle with, but it does come down to credibility here.


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