May 13, 2010
Markets can be irrational, as Keynes famously pointed out, and the Eurozone/Greek crisis is a classic example. “The markets” for months have been demanding more blood from Greece, as the financial press has continuously and often unquestioningly reported. More commitment to spending cuts, tax increases, and “procyclical” policies that the bondholders, EU authorities and IMF have also demanded. As I noted yesterday, this just pushes Greece deeper into recession, and doesn’t even make it more likely that they will pay off their debt in full. The same is true, to varying degrees, for the other weaker Eurozone economies: Portugal, Ireland, Italy and Spain.
So why do they do it? I have been asked that question many times recently, and of course I can’t speak for the EU authorities or the IMF, which in this case is subordinate to the former. The most likely explanation is one proposed by George Soros nearly a decade ago to explain such attitudes during the Argentine crisis: punishment. The Greeks (and others) must pay for their governments’ “profligacy,” lest others be tempted to run up unsustainable debt. “The markets” and the authorities who follow their dictates don’t particularly care about the injustice of punishing the general population for decisions made by a few. But do they care if they are making the economy worse and possibly reducing the chance that the bondholders get paid in full? Or weakening the whole Eurozone economy? Or possibly worse, exacerbating “systemic risk,” as we saw in the wild ride of worldwide stock markets last week?
With regard to the latter, it was probably the following weekend reversal of position from the European Central Bank, more than the trillion-dollar fund that was created, that calmed the markets. As Bloomberg reported:
“The European Central Bank said in a statement it will intervene in government and private bond markets ‘to ensure depth and liquidity in those market segments which are dysfunctional,’ and central banks in Germany, Italy and France began buying government bonds yesterday. The ECB restarted a dollar-swap line with the Federal Reserve.”
It was the ECB’s refusal to commit to exactly this last Thursday that launched a panic in worldwide markets, by driving up interest rates for interbank and other loans in Europe. It is difficult to understand the ECB’s willingness to play this game of brinkmanship as anything other than ideological. The Eurozone’s projected inflation (consumer price index) for this year is 1 percent, and 1.5 percent for next year. Are they really afraid that these interventions to ensure liquidity will cause too much inflation in the Eurozone?
