Can Draghi do 'whatever it takes' to save euro?
- 1 August 2012
- From the section Business
As we wait to see whether Mario Draghi and the European Central Bank will tomorrow announce "whatever it takes" to save the euro (to use his resonant phrase of last week), it is worth reminding ourselves of the eurozone's unhealthy lifestyle (forgive my anthropomorphising please).
Since 2009, its history has been of fiscal and banking crises that force eurozone leaders to make modest reforms, which provide calm for just a few weeks and months, till there is another crisis and more modest reforms.
So if you were the eurozone's physician, here is why you would be concerned.
The crises have become progressively more serious: the €500bn or so that Spain may need in a bailout is more than four times Greece's initial rescue needs in 2010.
But there has been limited progress towards the kind of political union - or central control of budget-making, borrowing and supervision of banks - that many would see as necessary to the eurozone's long-term survival.
So have the crises now reached such a magnitude that some time soon the eurozone's leaders will be jolted into taking the kind of serious evasive action which would see future shocks diminishing in their severity?
Or are the forces of financial and economic contraction now so powerful that they are incapable of being solved by any of the tools likely to be at the disposal of the European Central Bank and government leaders in the foreseeable future?
One strand of these negative financial trends has been elucidated by Morgan Stanley, in what it calls the balkanisation of the eurozone banking system.
Its banking and money team have highlighted how the weaker eurozone economies - Spain, Italy, Portugal, Cyprus, Greece and Ireland - have been progressively starved of credit as banks in the bigger, stronger economies of Germany and France have stopped lending to them.
Here are a couple of striking and disturbing statistics.
According to data published by the German central bank, the Bundesbank, net lending by German banks to Spain, Italy, Portugal, Greece and Ireland rose from €67.4bn when the euro was launched in 1999 to a peak of €510bn in November 2008. In other words, banks behaved as though the eurozone was a seamless unified banking market.
But since then, total net credit provided to these economies by German banks has more than halved, to €241bn in May - and there has been a net contraction of credit of more than €60bn in just the last six months. Or to put it another way, banks are increasingly seeing themselves as national institutions again, rather than euro institutions.
As for France's banks, they have also been retreating back to their home market. According to Morgan Stanley, their net lending to the rest of the eurozone reached a peak of €742bn as late as April 2010, but has since plunged to €489bn. Morgan Stanley expects this repatriation of lending by French banks to continue - and warns this could be particularly deleterious for credit availability in fragile Italy.
Or to put it another way, the unbreakable link between credit provision and economic activity means that recessionary conditions in Spain, Italy and the weaker eurozone economies will intensify, as French and German banks take their money back.
Now there is only so much the European Central Bank and national central banks can do about this. It can flood domestic Spanish and Italian banks with liquidity or cheap loans. That stops them from falling over, at least until they run out of acceptable collateral (and see this previous post).
But it can't compel those southern European banks, many of which are chronically lacking in confidence, to provide additional loans into the real economy to compensate for the sucking out of credit by banks from northern Europe.
That said, there is an expectation that the European Central Bank will start to penalise banks for holding money on deposit with it, rather than using that cash to make loans, by charging negative interest rates for deposits. This could happen tomorrow or in coming months.
However for Morgan Stanley, the risk aversion of German, French and other northern European banks is now so entrenched that it does not expect them to cease their withdrawal of credit from Spain, Italy and the other weaker economies, even in the circumstances where the ECB penalises them for sitting on cash.
And for Italian and Spanish banks, in today's febrile climate there is a strong temptation to put any spare cash on deposit with central banks, even for a guaranteed loss on that money, because they don't want to double up on lending to households and businesses struggling to repay what they owe, and they don't want to be short of cash if capital flight intensifies.
It would mean contractionary conditions in those weaker economies would be sustained and could intensify.
That in turn would cause tax revenues for their governments to continue to shrink, such that reducing public-sector deficits would become a never-ending labour of cutting expenditure and raising taxes.
In those circumstances, austerity programmes would become a prison with impossibly high walls, not a route back to rehabilitation and credibility in the eyes of commercial investors.
In other words the solution is the same as it ever was, and may be as politically impossible as ever it was: the Germany government would need to provide official underwriting for the funds borrowed by the Italian, Spanish and other eurozone governments, what is known as mutualisation of borrowing, to reduce their borrowing costs and provide assurance of credit supply.
If that potential solution remains some way off, how concerned should we be?
Well the boss of a big global bank yesterday told me he is convinced that that the eurozone will continue to lurch from crisis to crisis but will muddle through - and that eventually the political reforms will be adequate. For him, the crises are the just-about-acceptable price of spurring eurozone leaders to do the right thing.
Maybe he is right. But I feel obliged to point out that this banker - like pretty much all his peers - has for three years consistently under-estimated the magnitude of what has gone wrong in Europe's currency union.