Begging for the Bazooka Europe's Dangerous Dream of Unlimited Money
This week, some euro-zone members have been calling for the permanent bailout fund to be provided with a banking license that would provide it with unlimited access to money from the European Central Bank. The "bazooka" option might help crisis countries in the short term, but it would entail massive risks in the long run.
The bazooka isn't just the name of a portable American antitank weapon. Recently it has also become the synonym for a financial super weapon that is supposed to end the euro crisis once and for all. There also used to be a chewing gum called Bazooka that was sold in German supermarkets until the 1980s. Once the pink stuff got stuck somewhere, it was hard to get rid of -- not unlike the current discussion about a euro crisis bazooka.
The bazooka debate heated up after a suggestion from some countries, including Italy and France, that the permanent euro rescue fund, the European Stability Mechanism (ESM), should be equipped with "unlimited firepower" through a banking license. In concrete terms, it would enable the ESM to borrow unlimited amounts of money from the European Central Bankand use it to shore up euro-zone member states threatening to buckle under the weight of the crisis.
Given that billions of euros have already been deployed in the euro crisis, the idea of unlimited credit seems risky to say the very least. Not surprisingly, the reactions have been intense. "A banking license for the ESM would mean firing up the money printing machine, which means inflation and nearly unlimited liabilities," Patrick Döring, the general secretaty of the business-friendly Free Democratic Party, the junior partner in Chancellor Angela Merkel's government coalition, told SPIEGEL ONLINE. "That is why the FDP cannot and will not allow a banking license to be issued."
So how is it that the supporters of a bazooka have come upon their demands? Ultimately, it goes back to the basic problem of the euro crisis: Countries like Spain and Italy are suffering from mounting debt and worsening economic prospects. To borrow fresh money they have to offer investors higher interest rates to buy their bonds. That further increases their debt and uncertainty over the future, which in turn continues to increase the risk premium they must pay to investors.
For two and half years now, euro-zone countries have tried to break this vicious cycle. First they created rescue plans such as the European Financial Stability Facility and its successor, the ESM, which are intended to provide countries like Greece and Portugal with loans until they are able to borrow money independently on the markets again. To prevent the need for further emergency bailouts, the European Central Bank has also sprung into action several times. It bought large quantities of bonds from distressed euro-zone countries to place downward pressure on interest rates. In addition, the central bank made loans of more than 1 trillion ($1.23 trillion) available to European banks in the hope that the institutions would in turn invest at least part of that sum in government bonds.
But all of these efforts have been met with limited success -- and interest costs have risen sharply recently, especially in Spain. The reason is that many investors are worried that the bailout funds will prove to be too small if other euro-zone countries ultimately need to be rescued. Spain and Italy alone could require around 1 trillion if they have to seek a bailout, estimates Bantleon, a fund company that specializes in bonds. Currently, however, the euro bailout funds are only capable of providing a total of 750 billion.
Switzerland Leads the Way
Supporters of the bazooka solution say that pressure on euro-zone countries won't relent as long as a concrete number is affixed to the scope of the bailout funds. Regardless whether the view comes from genuine conviction or pure speculation, the idea is that time and time again investors might decide that support is insufficient and thus drive interest costs up again. Only a safety net with unlimited scope -- at least so it is hoped -- would put an end to that kind of speculation.
Most recently, the Swiss national bank proved that such a deterrence strategy can work. After the Swiss franc rose sharply as a result of the crisis, monetary authorities pledged to defend the franc at a rate of 1.20 francs to the euro through unlimited foreign exchange purchases. They were largely successful with the strategy.
An ESM that has greater leeway could also mean freeing the ECB from a Catch 22. The central bankers' work should actually be limited to price stability because they are forbidden from financing states. With its euro-zone relief efforts, however, the ECB has moved into a legal gray area that is threatening its very independence. It would therefore make sense for the ESM to take over government bond purchases in the future.
Nevertheless, the newly introduced plan would not truly limit the ECB's liability given that it would allow the ESM to submit its newly purchased sovereign bonds as collatoral to the ECB in exhange for additional loans. The ESM could use that credit to support crisis countries with loans or further bond purchases. In other words, the ESM would be nothing more than an intermediary for state financing through the ECB.
And that's not the only argument against the bazooka. When there is de facto unlimited money and artificially low interest rates, the threat of inflation rises. Even Christian Noyer, the head of central bank of France, a country that is pushing strongly for the bazooka, has conceded that large-scale bond purchases entail risks. "Large scale asset purchases are not without risks," he said in December. "Although they may help to eliminate upward pressure on interest rates in the short term, they will also affect price and financial stability in the medium run."
With the bond purchases it has undertaken so far, the ECB has also sought to counter the threat of inflation. It gave banks an incentive to increase their deposits with the ECB so that the net amount of money didn't rise. German economist Peter Bofinger recently argued in an interview with SPIEGEL that the threat of inflation would only begin to materialize if banks were to lend out money in a grand fashion -- a development that few would expect given the current cloudy economic situation.
Apart from the concerns about inflation, there is another strong argument against deploying the bazooka: the prospect of theoretically unlimited support from the ESM could lead euro-zone countries where reforms are so desperately needed to massively neglect those efforts.
Even if one assumes that speculation and panic are behind rising interest rates for euro-zone countries, it is also true that the affected countries undoubtedly have problems with excessive government spending, tax revenues that are too low and an erosion of competitiveness. The financial markets are forcing them to do something to change the situation.
Bazooka proponents, meanwhile, argue that countries are still capable of undertaking reforms once the pressure is taken off of them. But if the history of the European Union has taught us anything, it is that member countries rarely move unless they are placed under pressure.
With additional reporting by Florian Gathmann.