Relying on the ECB

Yannis Varoufakis, radical Greek economist and author of a leading blog on the ongoing Eurozone crisis, has given a compelling account of the present dilemma faced by Europe’s leaders.

He notes that with respect to today’s meeting of the Eurogroup, three issues are on the table. Firstly, what should be the percentage of the Greek write–down? Private bondholders agreed back in July to a 21% reduction in net present value. Today, the figure most often cited is 60%. Back in July, discussions raised about what exactly constituted a default and how much arm-twisting could private creditors take before their bruised limbs became evidence of a default. These discussions return today, with European governments and the ECB wanting to avoid a so-called “credit event”.  The Financial Times reports that bondholders, represented by the Institute of International Finance, are fighting the 60% figure, proposing their own plan which would see them recoup more of their money after a Greek default.

The second issue is about how much help should be provided to other peripheral Eurozone economies, such as Spain. This issue is also, though no one is talking about it openly yet, about what can be done to help Italy. The focus of this discussion is the European Financial Stability Facility. To what extent can it be used as a vehicle for providing guarantees to troubled Eurozone members? One idea is to create a purpose-built fund that can provide guarantees to those willing to buy the bonds of embattled sovereigns (Italy and Spain). Another idea is that a special fund be created that can buy these bonds directly. With regards to the former, Varoufakis notes the circularity of the idea: since Italy and Spain are involved in providing the EFSF with funds in the first place, if the EFSF was then to be used to provide insurance for those buying Italian and Spanish bonds, the EFSF would in effect be a façade behind which the Italian and Spanish treasuries were providing the insurance to those willing to hold their own bonds. The big difference, of course, is the German stamp on the EFSF façade.

The third issue is recapitalization. Disagreements prevail about how much capital is needed to insulate European banks from the consequences of sovereign defaults. The figure favoured by those meeting in Brussels is 108bn Euros: adequate, they say, to tide Europe’s banks over the rough waters of Greek default. For analysts, this is woefully inadequate as it assumes away the problem everyone is thinking about: what if a Greek default is followed by the insolvency in other larger member states, namely Spain or Italy.

Varoufakis’s argument is that the sums simply do not add up. The thin gruel of the EFSF cannot satisfy the demands of creditors. What is surprising is how heavily he relies on the European Central Bank. If the ECB can be made into a lender of last resort and be made to print Euros, then the circle can be squared. Failing that, Varoufakis suggests it can at least borrow in its own name on the international markets and then use that money to pay-off some of the continent’s sovereign debt. As argued before, this reliance on the ECB is a common feature of bourgeois economists. Charles Wyplosz has argued this consistently, as has Paul de Grauwe (see here and here). The problem is that it ignores – in one swift assumption – one of the main features of the current crisis: the way in which political constraints are closing in on governments, limiting their options. The ECB might be transformed into a lender of last resort on the back of a wave of federalist sentiment. But at present, as the isolation of national executives meeting in Brussels chafes against the demands of protestors and national political parties to be more closely involved in Eurozone decision-making, support for the EU is dwindling.

This development should be welcomed: the narrowing of executives’ freedom of manoeuvre internationally is a sign of a more politicized and contested crisis at home. To rely on the ECB is to wish these political developments away. Perhaps Varoufakis thinks European populations do support a leap towards fiscal integration and that what is holding them back are national governments. But there is little evidence of this on the ground. Relying on the ECB might make mathematical sense but it pays scant regard to the politics of the current moment.