The ECB is becoming nervous! Starts using blackmail and fearmongering as a weapon to hold back Greece from restructuring debt.

I have written various posts on the precarious situation the Greek government is in: "should or should we not restructure our debt and how will the Euro zone react to this"?!


Lorenzo Bini Smaghi, member of the Executive Board of the ECB, held at 10 May 2011 a speech at the Europe Festival Conference on “The state of the Union”. In this speech, he was clearly fearmongering and blackmailing Greece not to talk about restructuring debt or else…?!
Here are the most important snips from his speech, accompanied by my comments where relevant.

There is no doubt that there are currently substantial differences within Europe, with some countries demonstrating a strong capacity to adapt to the new global conditions, while others are finding it hard to implement the changes that are necessary to maintain their level of prosperity and continue to grow. These differences are not confined to Europe. Contrary to what some observers say, I think that the anti-Europe movements that have emerged in some countries are a symptom of a more general dissatisfaction linked to the structural factors of the crisis. In the United States too, society is deeply divided on how to face the challenges of globalisation.

Ernst: Bini Smaghi is right where he speaks of substantial differences within Europe. You could talk of a Europe of two speeds, with ‘succesful’ countries as Germany, The Netherlands and France on one side and (f.i.) the PIIGS on the other side. The latter are highly indebted countries with high unemployment and low possibilities for industry, services and exports to raise the economic activity and GDP of the country. 


Mentioning the ‘anti-Europe movements’ as ‘a symptom of a more general dissatisfaction linked to the structural factors of the crisis’ is a little bit cheap. It ignores the genuine and justified reproaches that these movement have against the (often) undemocratic and technocratic decisions that the EU and the ECB have taken, concerning the euro and the credit crisis.

Although European institutions provide an easy scapegoat, they represent an element of extraordinary strength in the current circumstances, not only for Europe, but also for the Member States, giving them – I believe – a great advantage. In a severe crisis, which requires prompt action with long-lasting effects on the lives of citizens, the risk of a mistake is enormous, particularly if decisions are taken in a monolithic society or there is a tendency to share a common mindset. The existence of European institutions does not eliminate the possibility of error, but forces together the different cultures and opinions that form the Union in the decision-making process. As a result, decisions may be wiser, even if taken in a cumbersome way and in a context of deep discord. One example is the decisions to support the three countries which experienced economic difficulties. Opinions differed within the Union. Some were tempted to leave the countries to their fate, to pay for the mistakes they had made. But others were prepared to help – even unconditionally – thinking that in future they might benefit from the same assistance if needed. In each case it was difficult to forge an agreement, but finally a balanced solution was found with a view to creating the appropriate incentives for adjustment.

Ernst: We, the ECB, advise you to believe in… the ECB. The sentence about ‘European institutions providing easy scapegoats’ almost brought tears to my eyes (with the help of some onions). The tone-of-voice of this paragraph about countries with monolithic societies and common mindsets, discloses how the mindsets of ECB leaders need a tune-up. I guess there are a lot of inflated ego’s there. I am not at all convinced that the decisions of the European instituations are wiser than the decisions of individual countries. Mostly, in those circumstances is chosen for faint-hearted agreements that promise everything, but deliver nothing, due to wooly language and empty promises.

Overall, I believe that Europe has the ability to meet the challenges that the western world faces, if it is able to make full use of its own experience and institutions. Changes are nevertheless needed. And this brings me to the questions specific to Economic and Monetary Union.

In this regard, I would like to make two main points: first, the global economy is becoming increasingly “multipolar” and the euro will have to stand its ground alongside at least three – and possibly more – other major international currencies. Second, the euro can only be assured of a major role in a multipolar currency world if the architecture underlying the single European currency is sufficiently strong. The task of achieving this cannot be delegated to financial markets and requires appropriate institutional steps.

Ernst: What the financial markets did prove here is that the architecture underlying the single European currency is not sufficiently strong. Every few months countries like Portugal, Greece, Ireland and Spain were put to the test and up to now all failed it. I am not referring to Moody’s et al. lowering the ratings for these countries, but the fact that interest for Greece, Portugal and Spain is more than twice as high as the interest for Germany and The Netherlands. If the financial markets suspect that the Portuguese, Greek or Spanish shit has hit the fan, they can wear out all of ECB’s attempts to stabilize the markets. Everybody who doesn’t understand it, can better look for another job. The (in)voluntary attacks on the PIIGS will remain coming and coming, until the Euro zone collapses or until individual countries default.

The US dollar has remained the main international currency, as a result of the predominance of US financial markets and also the inability of several emerging economies to pursue independent policies (for example by de-pegging their currencies from the US dollar). But there is little reason to believe that these factors will not change over time. The renminbi, in particular, should be in a position to relatively quickly emancipate itself from the dollar and become a major international currency if the Chinese authorities were to consistently pursue capital account liberalisation, greater exchange rate flexibility and all related policy measures in the years to come. The international role of some other emerging market currencies is also likely to increase over time.

Ernst: If Bini Smaghi thinks that this requisite babble about the Chinese will push prime Minister Hu Jintao in letting the Yuan float, he is so naïve. The Chinese government thinks currently that it is not in its interest to let the Yuan float. Until the government changes its mind due to internal unrest in China as a result of (hyper) inflation and housing bubbles, no speech by a foreign official will achieve this.

We are clearly moving towards a multipolar currency world. The question is whether the euro will be one of the poles – so to speak – of the new system. I will not dwell on the advantages for Europe of being one of the poles, but rather I invite you to reflect upon what would happen if it were not. To be sure, the euro, like any other currency, would be affected by economic and political developments in the countries issuing the leading reserve currencies, and would suffer severely from external shocks.

Ernst: In my opinion it doesn’t matter so much if your currency is considered a leading currency or not. The world is so interconnected currently that every large economic event in one country influences economic events in other countries. The Euro won’t put Europe on an island.

This points to the conclusion that in a multipolar world having appropriate domestic macroeconomic policies is not sufficient to absorb external shocks. Unless a country or an economic region also has a deep and liquid capital market and its size is sufficient to absorb large capital flows, it is bound to become subordinate to the existing poles, or to be squeezed between them. The prosperity of the euro area countries is inextricably linked to the success of the euro.

Here today I would like to warn against an illusion which seems to be spreading among policy-makers in Europe. The illusion is that the economic governance of the euro area can be strengthened not by increasing the responsibilities of policy-makers, which would mean stronger European institutions and stronger rules, but rather by delegating to financial markets the task of selecting the appropriate policies that authorities must abide by, in particular with respect to budgetary policies.

Ernst: We, the ECB, advise you again to believe in… the ECB. The fact is that ‘selecting appropriate policies that authorities must abide by’ is not delegated by policy-makers to the financial markets, but the financial markets just are testing the policies of the European institutions. And uptil now the score is: financial markets vs. European institutions 2-0.

One avenue that has been advocated by some is to make more explicit the conditions under which countries, like companies, would not repay their obligations and would restructure their debts or even default. The proponents argue that such explicit rules would improve the ability of markets to price sovereign risk and, thus, to exert discipline on governments with a view to achieving sounder fiscal policies. This view is predicated on the general principle that investors should bear the consequences of their decisions.

Although at first sight this may seem reasonable and fair, it is wrong not only in theory but also in practice. The reasons are simple and include the following:

First, as over 50 years of IMF experience have proven, market assessments of the solvency of countries tend to be wrong. In the vast majority of cases, sovereign risk is overestimated or underestimated over a long period. This is because sovereign risk does not depend only on debt sustainability, but also on the political will to implement adjustment programmes, including privatisations and structural reforms.

Second, at times markets have perverse incentives. In particular, large investors who have bought insurance against sovereign default, often without holding the underlying asset, stand to benefit greatly from the default and lobby in favour of it. They tend to encourage naïve governments to believe that debt restructuring can be done in an “orderly way”, distracting them from implementing the appropriate policy adjustment.

Third, default or debt restructuring is a dramatic economic and social event for the country which experiences it – I would call it political “suicide” – which leads many into poverty, as experience has shown. It is thus rather peculiar for policy-makers to design policies mainly with the aim of punishing (or rewarding) certain categories of investors, rather than considering the ultimate consequences for the people.

Finally, if the euro area were to go down the path of leaving it entirely up to the markets to decide which countries are solvent and which are not, it would put the euro at a disadvantage compared with all other major currencies. This is confirmed by the fact that since mid-October 2010, when the idea of private sector involvement in programmes to assist countries experiencing difficulties was voiced at the highest political level, and in spite of subsequent clarification that in fact no change had occurred in prevailing practices, some euro area market segments have severely suffered. The benefits of a deep and liquid financial market where international investors feel safe to invest have been jeopardised, undermining the competitiveness of the euro.

Ernst: First bullet: ‘Market assessments of the solvency of countries tend to be wrong’: “listen to us, we of the ECB know better what is good for you, than you yourself.…”. It is this kind of arrogance that sheds a bad light on the European institutions. Of course the markets are not always right, but it is a fact that governments in crisis situations often don’t tell the truth. What the financial markets at least do is to disclose fairytales about the economy of individudal countries. And there is no adjustment programme that can tear down in weeks the financial imbalances that have been created in years. Spain, Greece, Portugal and Ireland cannot only be saved by an adjustment programme.

Second bullet: the fairytale that speculators can benefit from Credit Default Swaps should be over by now. If there are for trillions of euro’s in CDS’s in circulation on the PIIGS, the chance that nobody gets paid in case of a default is about 100%. There is no insurance company strong enough to pay out all CDS’s. Remembering AIG?

Third bullet: this is were the fearmongering and ‘blackmailing’ of Greece begins. Defaulting will seal the doom for Greece and will put people into poverty. B*llshit: paying for European emergency funds as long as the last taxpayer is standing is also not the solution for the Greek, Spanish, Portugues, Italian and Irish problems. The list of current and possible problem countries in Europe is just too long to keep paying to emergency funds and hoping the crisis will blow over before the money is gone.

Final bullet: more fearmongering and blaming politicians in other countries.

The alternative is for policy-makers to take responsibility and strengthen the economic governance framework of the euro area, in at least three ways.

First, the governance framework underlying budgetary policy requires bold changes, with greater automaticity and stronger commitment on the part of policy-makers to ensure full compliance with the Stability and Growth Pact. ^[3]

Second, further progress should be achieved in the implementation of the single market, strengthening the “economic leg” of EMU.

Finally, we need to further integrate regulatory and supervisory institutions for the financial sector at the European level, either by reinforcing efforts to harmonise practices across Member States, or by further strengthening European authorities.

A great deal has been achieved over the past few months, but much remains to be done to put the Union in a position to meet the challenges which have emerged as a result of the crisis.

Ernst: I actually agree with these conclusions. These are all sensible measures to reinforce the Euro zone for the future.

But when a tap is leaking strongly you can call the plumber and wait until he is there to solve your problem, while spreading towels on the floor. Or you can shut down the water first. And in this case Greece and Portugal are the leaking taps that need to be shut off from the water first. It is inevitable that these countries need to restructure their debt, instead of being loaded with more and more debt in the form of financial band-aids. These countries are leaking money as water and until they restructure their debt and are being put under supervision while solving their financial issues, nothing will really change.