Global Crisis Blog

The European Central Bank is a Logic-Free Zone: A EUlogy for the EUro

By Shlomo Maital


Writing in today’s New York Times (May 22), Nobel Laureate Paul Krugman, whose creative thinking made all of us rethink trade and geography, tears a strip off the European Central Bank (ECB) and its retiringhead Jean-Claude Trichet.  

   Krugman notes how in the U.S., a fierce debate rages between those who think government spending should be maintained,as the only prop under a flagging economy characterized by uncertain consumers who fear for their jobs,  and those who think government spending should be slashed, to halt the implacable rise in stifling debt.  But in Europe?  It’s all about austerity:

In Europe … the pain caucus has been in control for more than a year, insisting that sound money and balanced budgets are the answer to all problems. Underlying this insistence have been economic
fantasies, in particular belief in the confidence fairy — that is, belief that slashing spending will actually create jobs, because fiscal austerity will improve private-sector confidence.

   Despite a total lack of evidence on behalf of the “pain caucus”, Trichet continues to back it.  The result is catastrophic for Greece,  as well as Portugal, Ireland, and perhaps Spain.  Greece desperately needs debt
relief.  But under Trichet, backed by Merkel and Germany, it will never get it.

….. the E.C.B. is acting as if it is determined to provoke a financial crisis. It has started to raise interest rates despite the terrible state of many European economies. And E.C.B. officials have been warning against any form of debt relief — in fact, last week one member of the governing council suggested that even a mild
restructuring of Greek bonds would cause the E.C.B. to stop accepting those bonds as collateral for loans to Greek banks. This amounted to a declaration that if Greece seeks debt relief, the E.C.B. will pull the plug on the Greek banking system, which is crucially dependent on those loans.

  I believe Greece has no alternative. Faced with a stubborn, unyielding Central Bank (remember, the ECB is also Greece’s Central Bank, not just Germany’s),  Greece has no choice but to withdraw from the euro system, return to the drachma, devalue the drachma by half, and relaunch its economy, while restructuring its debt burden unilaterally, with the government assuming much of the bank debt and repaying it over an extended period.
This will involve much short-term pain, but long-term gain.  There is no time to lose; the longer Greece waits, the harder it will be.  And don’t count on Trichet’s replacement to be any different;  he too will be a pro-pain pro-austerity advocate. 

   Krugman concludes:

    If Greek banks collapse, that might well force Greece out of the euro area — and it’s all too easy to see how it could start financial dominoes falling across much of Europe. So what is the E.C.B. thinking?  My
guess is that it’s just not willing to face up to the failure of its fantasies. And if this sounds incredibly foolish, well, who ever said that wisdom rules the world?

   When a central bank makes a region with some 380 million people a “logic-free zone”, the whole world is put at risk.   Prepare your EUlogy for the EUro.