New Deal 2.0
Marshall Auerback warns that Germany’s obsession with a defense against the external threat of inflation is blinding them to the real risks facing Europe….
..By the same token, the creation of a common currency via monetary union has created market expectations that one country’s paper is as good as another, which explains why, for so many years, “fiscally profligate” nations such as Italy were able to borrow at Germanic level interest rates. But the decision a few months ago by the European Central Bank to block a basic “repo” function — namely, the purchases of a number of European commercial banks of Greek government debt and exchanging this debt via repos with the ECB for German and French government paper is what appears to have initially triggered the Greek crisis and raised issues of Athens’s potential insolvency.
From what we understand, the cessation of this repo function was largely done at the behest of the Germans, who saw this activity as a kind of “back door monetization” which would lead inevitably to inflation. This, despite the fact that the entire euro zone is characterized by huge unemployment , high output gaps, and collapsing domestic consumption. All of this at the core is being driven by Germany’s pathological fear of inflation which they see as the inevitable consequence of excessive government budget deficits.
But Germany’s irrational fears of inflation are storing up the conditions for a far greater crisis down the line. The euro contagion could now very well spread to Italy Portugal Spain and Ireland, all of which (under the terms of this package) have to lend to Greece, at around 5%. So what happens to their funding costs? They go north of 5% as a next step. In the US, when good banks took over bad banks, they became bad banks themselves (see Bank of America and Countrywide). And what about the seniority structure of these loans? Do they subordinate Greek Government Bond holders? One assumes yes, but this is not made clear by the rescue package. In short, this appears to be a cobbled together solution, and it won’t work for a Spain or an Italy. There’s no clarity even on how it gets ratified. The EU says it’s done, but Germany and Holland say they need Parliamentary approval (which can easily be delayed)… (link to full article)
