Euro on the brink [By Liu Pei/China.org.cn]
The most despised word for people currently in charge of the European Central Bank (ECB) and the EU's deeply in-debt peripheral countries is probably "balance." The word gets uttered thousands of times by all stake holders, but the most obvious of ideas is so beyond their reach.
ECB President Mario Draghi is among those most tormented by this word. Although he has been quite aware that the biggest problem in the PIGS (Portugal, Ireland, Greece and Spain) is imbalance in both fiscal policy and economic structure – and for a period of time refused to bail out these countries – he cannot afford to abide by the non-refinancing rule of the ECB. Along came "LTRO" (Long Term Refinancing Operation), in which Draghi got himself trapped in the "balance" trick to either buy time or implement reform.
However, despite Draghi's efforts for a comprehensive reform, he was headed down to achieving only the former. The market rallied to two rounds of LTRO that injected 1 trillion euros in total cash into the European banking system. They helped to repress the surging yield of the government bonds and boost investor confidence, thus allowing more time for the governments of PIGS to restructure their fiscal policies.
For a while, it was good. The capital market reacted positively, the euro seemed to have strengthened, auctions succeeded at reasonable yields – silver was lining the clouds.
Perhaps not unexpectedly, everything came crashing down a month later. The Spanish government announced it was unsuccessful in cutting deficits, and 10-year government bond yield instantly surged to 6.6 percent. The market and policymakers reluctantly admitted that LTRO was not the game changer.
The huge cash infusion could not solve the EU's sovereign debt crisis; it only extended the fuse. Since the banks borrowed at the low interest rate of 1 percent from the ECB and purchased government bonds for a much higher yield, they originally had the will to take full advantage of it. As it turned out, banks in PIGS countries, especially Spain, were under pressure much greater than expected. According to Bloomberg, the value of 5-year government bonds which Spanish banks had bought plunged 26 percent, resulting in more losses to the banks. More detrimental problems could still be on the way if the trend continues; if the banks cannot stabilize, it could demolish market confidence.
LTRO can continue injecting liquidity to the market and helping the PIGs to avoid disaster-level default, but the ECB and the debtor countries and banks have failed to strike a balance between short-term rescue and long-term reform.
Balance is also urgently needed between austerity measures and economic growth. As is known to all, the PIGS are going through harsh times of austerity, cutting government expenditure in every possible way.
Many economists worry that these countries may fall into the austerity syndrome – too much austerity kills economic growth. Government expenditure contributes to a country's total demand, which creates jobs, increases household income and stimulates consummation and production. So this is an integrated circle, with elements inseparable to each other.
Meanwhile in the PIGS, government expenditure is shredded and public investment is all but frozen. Bank loans are devalued, leading gloomy credit confidence and rampant unemployment. Even the southern Europeans, who are known for their romantic idealism, cannot dream to achieve a balanced recovery with severe austerity.
According to the Talyor Rule, a monetary policy rule which stipulates how much the central bank should change the nominal interest rate in response to changes in economic conditions, Spain should require a main policy rate of -5.5 percent, meaning it is in great need of an aggressive form of quantitative easing, instead of an ever deepening austerity and less-than-effective deficit reduction.
Owing to the imbalance, the market speculates that ECB will completely throw away its non-refinancing principle, and begin directing bond purchasing. Just like the U.S. Federal Reserve, this will be more direct and bail out the PIGS by printing grey backs. Is this the way to strike a balance? The ECB cannot yet know – possibly not until bigger guns of the EU and the IMF step in. How they could finally install real growth could be the key to striking a balance and helping European countries out of the woods.
The author is a financial journalist mainly covering international finance and fiscal policy.
Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.