Stuck in a European Monetary Funk

Greece’s terrible public finances have not just been caused by its budgetary extravagance but credit-rating agencies have also been cited as triggers of its economic misfortune by having unhelpfully downgraded Greek government bonds. France and Germany have called for an investigation into the so-called “naked” trading of sovereign CDSs and some blame has been shifted onto the unprincipled speculators who had bet against bonds, helping to increase borrowing costs. One other problem for Greece has been the lack of a central Eurozone authority for helping out cash-strapped countries. Even worse for the nation, the ECB is going to tighten up its lending rules again after the deceleration of the global recession. The country will find it difficult to borrow if Moody’s Investors Service cuts Greece’s credit rating, meaning its government bonds would no longer be collateral at the central bank. The Greek Prime Minister George Papandreou recently designated €4.8 billion of additional deficit cuts in a bid to convince other European nations and investors he could regain control of the budget. The government aims to reduce its shortfall below the EU’s 3% of GDP limit by 2012. An “EMF” (European Monetary Fund) has been proposed to help deal with Greece’s problems and German Chancellor Merkel and Finance Minister Schäuble seem serious about the scheme. According to the Financial Times, some have accused them of using the idea to persuade German public opinion and “prepare a short-term fire brigade operation for Greece”. By the time an EMF could be set up, however, it would be irrelevant to Greece. The purpose of the fund now would be to ensure that a repeat of the Greek situation could be prevented in any other European nations in the future. A Greek official said to the FT on 10th March that: “Support from European partners is key in this kind of situation. An institutional format such as an EMF would be an advantage for us or any other small Eurozone country.”
When Schäuble brought up the idea of an EMF, he said it would act as a lender to Eurozone countries that could not raise funds in capital markets. It would not be a “competitor” to the IMF (based in Washington, DC) but it would try to regulate the fiscal policies of negligent member countries. Jean-Claude Trichet, European Central Bank President, hinted that he might support the proposals and some ECB policymakers are supportive of the plans to strengthen the political effectiveness of Europe’s 11-year-old monetary union. The rules governing the operation of the single currency proscribe a bailout for a country on the brink of insolvency. Mr. Trichet has backed the idea that in extreme cases outside help should be provided. Greece is supportive of the proposal as a potential lifebelt to get it out of its debt crisis. There are no major policies to change the central bank’s workings, however, and Trichet said in a speech at Stanford recently that: “We view the pre-crisis operational framework as a very natural reference point for our phasing-out process.” The ECB has “relatively little reason to change fundamentally what has served our monetary policy well, both in normal and crisis times”. He also said that “we do not wish to breed dependency” and therefore “…a delayed exit from extraordinary liquidity support would distort market behaviour and misallocate credit”.
The European Commission has been using powers recently instated by the Lisbon treaty to establish more “budgetary surveillance” on the 16 participatory countries. More economic policy co-ordination between the nations is seen as an essential tactic in preventing a repeat of the Greek situation and European Commissioner for Economic and Financial Affairs, Ollie Rehn said that: “The Greek case is a potential turning point for the Eurozone; if Greece fails and we fail, this will do serious and maybe permanent damage to the credibility of the European Union. The euro is not only a monetary arrangement, but a core political project of the European Union … In that sense, we are at a crossroads.” A new single currency regime will be unveiled next month by Rehn of “rigorous surveillance of national budgets”. Also Eurostat is to be given new auditing powers over Eurozone member states.
Axel Weber, Bundesbank President, had warned that the proposals would be a distraction from attempts by countries such as Greece to bring their public sector deficits back under control and the French Finance Minister, Christine Lagarde, said that it was not an “absolute priority” for the European Union. The idea would most likely be met with much resistance from elsewhere in Europe if it required changes to European Union treaties and Angela Merkel has acknowledged an EMF could not be set up without changes to the EU, which seems a daunting task. Other policymakers have argued that Europe would be better served by finding ways to work better with the IMF instead of setting up an entirely new institution because the ECB’s big worry is that an undertaking could undermine the effective implementation of the EU’s financial policies. Stephanie Flanders of the BBC believes that the economic problems afflicting the Eurozone PIGS (Portugal, Ireland, Greece and Spain) are serious and that there are two big issues standing in the way of the liquidity solution. There is the problem, firstly, of diverging European competitiveness. It is essential that countries in trouble, such as Greece, try to restore their competitiveness and this can only be achieved with more balanced growth. Solvency is the other problem and many economists think that the floundering members of the Eurozone are going to come out of the process of restoration with unsustainable levels of public debt. A mechanism to effectively restructure sovereign debt is what is required and according to one American financial expert, Carmen Reinhart, “an organisation that could oversee orderly sovereign defaults in the Eurozone would fill a useful gap in the existing financial architecture…the Eurozone needs a crisis response mechanism for dealing with the likes of Greece.” It also needs “bold new policy initiatives”. This would help Eurozone countries expand, grow, and restore together.