Good friend Ramana and batchmate from IIM-A days sent me the link to an interesting piece by Richard Evans on the historical background to the German aversion to inflation and their inflation phobia. Those who have read ‘Lords of Finance’ would be familiar with the contents of the piece by Richard Evans. Others would find it fascinating to read the turbulent and painful history of Germany in the 20th century that lasted nearly four decades.
[Parenthetically, I had covered this in my MINT column in July, 2010 inspired, no doubt, by Liaquat Ahamed’s ‘Lords of Finance’. Germany/ECB is setting policy for the 1920s while the Federal Reserve is setting policy today for the 1930s]
The interesting issue is that the market is validating German inflation-phobia. Last week’s German government bond auction went so poorly that the Bundesbank had to pick up nearly 40% of the debt auctioned. Far from strengthening the case for the European Central Bank buying bonds of Italy, Spain, etc. in unlimited quantities, this failed auction underscores the risk to the core countries from such an approach. It is a quicksand that would drag and drown them all in. The failed bond auction is a warning from the market that the risk of inflation is too high in the Eurozone to justify such a low yield, even from Germany.
Those who advocate/suggest that Germany should shed its fear of inflation and allow ECB to print and buy European debt in unlimited quantities – Richard Evans is one of them – are guilty of one thing. Sure, they are not guilty of making a wrong suggestion. They are guilty of not admitting that the consequences could be global and are unforeseen in their magnitude. Surely, there will be a inflationary impact on the Rest of the World as it would breathe fresh life into commodities. How would the emerging world respond? Trade barriers? Capital Controls? Renminbi devaluation?
What would be America’s response to that remains to be seen? At one level, America would be happy at the complete transformation of the ECB into a clone of the Federal Reserve. That eliminates the threat of Euro emerging as a dominant international reserve currency. At another level, the resulting strengthening of the US dollar would be viewed with mixed emotions at best or negatively, at worst. America would not be able to engage in a stealth default of its public debt. Its stated goal of doubling exports would also be jeopardised.
This suggestion has been made not just by Mr. Richard Evans but by several others like George Soros, Martin Wolf, et al.
As is the case with the American Keynesians (think Paul Krugman), their vanity lends an exaggerated sense of certitude to their policy recommendations.
This blog has no shame in putting up his suggestion as a starting point for discussion among Eurocrats!
Gavyn Davies, formerly of Goldman Sachs, has this new blog post on the various scenarios for the Euro. Check it out here. Subscription may be required. Look at the graphic embedded in the post. The way option (3) is presented is disingenuous. It is not easy at all. Will peripheral countries be prepared to lose fiscal sovereignty? If so, under what conditions? What is the quid pro quo? If the quid pro quo is that the Euro strengthens, that is no compensation at all. It is doubling the pain of surrendering fiscal sovereignty and accepting fiscal austerity. How will the ECB know where and when to stop with its bond purchases of the indebted European issuers?.
The truth is that, at this stage, all the easy answers are over. Either the pain is taken by the peripheral countries fully (unlikely), the pain is kept within Europe as far as possible or it is spread globally by the printing of the Euros. Actually, scratch that. All options would result in global pain. The duration and the intensity of the pain would differ depending on the option chosen. That is the only that remains to be established.
Felix Salmon thinks that the Federal Reserve has a lot to teach the ECB. Quite.