Euro contrast


This morning the Euro crisis moved on from the still unresolved Greek issue to Italy. There is nothing new here except that Italian PM Silvio Berlusconi said he would resign after an austerity package was passed and move the nation ahead into new elections.  How did that happen?

This highlights the critical difference between how the US has been handling the Depression so far, which has been primarily to spend our way out, versus the European belt-tightening austerity being forced on member nations. That difference is stark, but it was not a choice – the Euro system is set up so that it cannot do anything else. It’s that inflexibility that is driving the crisis which has the world running scared.

What happened was a complex chain reaction that spooked the markets, as most news does these days. Despite no love for Berlusconi in bond markets, the possibility of instability in Italy made everyone nervous. That caused a sell-off of Italian bonds which, as the market works, drives up the net interest rate on the bonds out there. Higher rates make it more expensive to borrow, which is to say that the already cash-strapped nation is going to take an even bigger hit by borrowing on higher interest. The rate just hit the point where Greece was forced to look for relief from its debts, which means that it may be time for the European Central Bank to step in and arrange a big rescue package for the much larger Italy.

Got it?

Nothing really changed overnight, but the potential for more bailout has increased. And that highlights the problem that Europe has right now which is a system duct-taped together without a strong central authority that could do what we have done here in the USofA – spend, print, and otherwise get a lot more money out in circulation. Our Federal Reserve has been able to make overnight loans and craft “Quantitative Easing” packages while the Federal government ran huge deficits because we can do that. The Fed simply buys up Federal Debt with money they more or less printed. Thus more money gets into circulation.

Contrast that with the European Central Bank (ECB), which cannot borrow on its own and has no related authority which can issue “Euro Bonds” backed by the member nations. It has to go to nations one at a time – usually starting with Germany and France – to ask for support for what they need to do. The bank itself has a very limited charter and their mission states clearly:

The European Central Bank and the national central banks together constitute the Eurosystem, the central banking system of the euro area. The main objective of the Eurosystem is to maintain price stability: safeguarding the value of the euro.

Translation: We ain’t printing more pretty bills here. Our job is to keep it all on an even keel.

There are some great benefits to a system like the ECB and its related institutions. One of them is that by giving them a charter to focus exclusively on price stability (inflation and deflation), they have a task they can manage well. Our Federal Reserve, by contrast, has to watch price stability internally, the value of the dollar as an international standard globally, and our balance trade inbetween. If that sounds like an impossible job to you … well, it is. Bernanke is doing the best he can. The Euro system has one big drawback which is that it cannot respond to a crisis as quickly as the US one because the ECB does not have enough authority on its own. Hence it has to beg Merkel and Sarkozy for cash, crisis by crisis.

Back to the crisis del giorno – what is up next for Italy? The magic point that was crossed was not a sign of impending doom but merely a line that has signaled trouble in the past. Investors generally do not want any more news out of Europe and this little tidbit has turned an otherwise fluid story into something that can be reported with black ink on a white page.

Nothing has really changed and everyone saw this coming a long time ago. But it highlights the inflexibility of the single currency system put together with duct tape and a complete lack of any central authority that can make things happen. Our system, despite its flaws, is far more flexible and responsive.  Remember this the next time a politician calls our Federal Reserve system “treasonous” or otherwise plans to abolish it.