Crisis Management Europe Eyes Anglo-Saxon Model with Envy

Should the European Central Bank follow the Anglo-Saxon model and buy up vast quantities of sovereign bonds in attempt to finally overcome the euro crisis? ECB head Mario Draghi is under pressure to act now. But what are his options?
A graffito showing ECB head Mario Draghi and German Chancellor Angela Merkel outside the construction site of the new bank headquarters in Frankfurt.

A graffito showing ECB head Mario Draghi and German Chancellor Angela Merkel outside the construction site of the new bank headquarters in Frankfurt.

Foto: KAI PFAFFENBACH/ REUTERS

Britain has it better. At least that's how it seems. The country's financial situation is improving, even though it was worse off than many euro-zone member states at the beginning of the financial crisis. It was more bloated, its financial sector was in bad shape and the country had one of the largest real estate bubbles and highest rates of private debt in the world.

But while large areas of the euro zone continue to be plagued by mass unemployment and stagnation, the United Kingdom  now appears to be on the road to health. The year 2014 could even see economic growth of 3 percent. Furthermore, investment is growing and the real estate sector is making progress.

In 2008, the situation in the UK wasn't all that much different than that in Spain. Yet while the British are slowly leaving the crisis behind, the Spanish would be ecstatic if they could avoid further economic contraction this year.

What is the fundamental difference between the two countries? Spain has the euro. Britain has the Bank of England.

The European Central Bank and the Bank of England will both publicize their next steps on Thursday. Whereas the entire world will listen closely to hear how ECB head Mario Draghi intends to counter deflation risks and credit crunches in countries like Spain and Italy, his Bank of England counterpart Mark Carney will more likely be confronted with questions about when he intends to begin tightening monetary policy.

Understandable Impatience

The US Federal Reserve's newly appointed chairwoman Janet Yellen is likely to be affirmed by the Senate on Monday, and has also indicated that she will begin scaling back the bank's crisis intervention programs immediately. It is the next step in the Anglo-Saxon strategy: That of pumping vast quantities of fresh liquidity into the market with concurrent currency devaluation as a way of softening the recession. And there are not a few, including the head economist for Deutsche Bank, who demand that the ECB  must also finally begin buying unlimited quantities of sovereign bonds from struggling euro-zone member states.

The impatience is understandable. The longer the crisis  continues, the more threatening it becomes. The differences in the credit markets of the common currency zone remain stark: Companies in Spain and Italy must pay interest rates that are almost double those paid by firms in Germany, if they are able to borrow money at all. Furthermore, the economic pain continues, along with all of the social and political consequences that result. When, in the sixth year of the crisis, all reform efforts, spending cuts and savings measures have still not generated reliable growth, isn't it time for the ECB to finally do all it can to kick-start the process?

A glance across the Channel shows how the Bank of England acted to prop up the economy. In the course of the crisis, the bank tripled its balance sheet total, particularly because it purchased vast quantities of sovereign bonds, a process known in financial jargon as "quantitative easing." The strategy resulted in low long-term interest rates and a shot in the arm for financial markets. By comparison, the ECB doubled its balance sheet total, but its direct intervention in the sovereign bond market had less impressive results.

Draghi now has two options: Either he can once again pump huge quantities of money into European banks as the ECB did in the winter of 2011/2012, but this time with the condition that the money must be loaned to companies in need of financing. That, however, would be a significant intrusion into the business operation of the banks, which would be forced to take on additional risks. Or the ECB could buy sovereign bonds, thus sinking long-term interest rates, a move which would only work were the bank to focus on purchasing debt from those euro-zone states that are struggling the most.

Draghi's Dilemma

But the ECB is apparently not allowed to take such a step. Legally, any systematic euro easing program would have to include all 18 euro-zone member states. Absurdly, that would mean that the ECB would be forced to buy primarily German bonds (in accordance with Germany's one-third share of the euro zone's gross domestic product) even though it is primarily Europe's southern states that need the help. The result would be that Germany's already extremely low interest rates would sink even further, the real estate bubble would grow even faster and it could even trigger inflation.

Draghi's ECB is facing a dilemma. It must prevent a disintegration of the currency union, but it has been left alone with this essentially political task by the governments in the euro zone.

The difference with Britain is glaring: The Bank of England serves Britain while the ECB serves the euro zone, an entity in name only, which is why there is no shared debt and no euro bonds that the ECB could buy up in the Anglo-Saxon manner.

The central banks clearly cannot solve the crisis on their own. At best, they can merely mitigate the symptoms. Furthermore, a more critical look at the economic data reveals that even the British economy is not particularly solid. The economy is hardly competitive, productivity is low and the trade balance is negative. And a new bubble is threatening its real estate market.

In Spain, on the other hand, harsh austerity is having an effect. To be sure, the country is still afflicted with a horrific unemployment rate of more than 25 percent. But reforms and belt-tightening measures have significantly improved Spain's competitiveness. Exports are on the rise and the country has a positive trade balance.

Spain should be able to reap the benefits of their exertions -- if the country's financial situation ultimately improves.

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