Solvent? Who said solvent?

The German government remains under attack for not “taking leadership” in the Euro crisis. This rests on the assumption that a known solution is ready to be implemented, but the German government just refuses to accept it. That is wrong.

How many times have you witnessed people changing their opinion about the Euro crisis, while being very confident at the time? This is Joe Stiglitz in February 2010:

If the rest of Europe stands behind Greece, interest rates will come down and then it is easy for it to service the debt. There is a vicious circle here: if people don’t believe it will service it, interest rates go up and then there is a problem.

“A default by Greece is absurd” is what he says later. Sounds familiar? It is the argument that is used for Italy and Spain these days, countries that are “illiquid but solvent” as the popular opinion goes. Isn’t illiquidity always a sign of doubts about solvency? Never mind. Paul Krugman, pointing to Paul de Grauwe, is endorsing this argument as well as The Economist, Willem Buiter, and many others.

I am not saying that Italy and Spain are insolvent (whatever that means for a sovereign country anyway), what I am saying is that their solvency is far from certain. I recommend to take a look at Germany, a country that went through eight years of painful internal devaluation, starting from a much lower debt burden. And it had a functional political and economic governance system (in comparison to Italy) that introduced a so-called debt brake completely without outside force based on a party-wide consensus. Add on top of that the indifference of most European economists and policy makers to the contractionary monetary policy of the ECB plus the fact that Germany was (and is) a big country within Europe and thereby a decisive factor for ECB policy, and the growth prospect for the periphery is bleak.

If Spain and Italy want a backstop – that realistically only the ECB can provide – it is their burden of proof to show that German taxpayer money, that does not grow on trees either, is worth risking in this operation. Because if it turns out that Italy or Spain cannot grow out of their debt because they lack the political will and macroeconomic discipline (as they did a long time ago), this backstop will come into effect, backed by German taxpayer money. And the more it is used, the more the negotiating power shifts towards Italy and Spain, who in this scenario would have shown their lack of political will and macroeconomic discipline… You get the idea.

In fact, Italy proved right away that this scepticism is not a phantasm: after the ECB started buying Italian bonds, the Italian government decided that it was not so serious about reforms after all, forcing the ECB to stop the programme.

How can Italy and Spain show that they mean it? I don’t know. Maybe by transferring government-owned enterprises and property as collateral to the ECB? Maybe through a country-wide consensus (!) on a debt-brake or on pension reforms? Or by giving the ECB the right to approve the budget? By legislation on wage setting that ensures that the economy will be competitive in the near future? To be sure, these are all difficult questions, but this proves my point: blaming Germany or its government is an unsatisfactory explanation for the political problems we face in Europe.

In my view, the problems have to get much worse, Greek-style, so that the peripheral governments can push through the reforms that are needed. Blaming Germany, the ECB, the IMF or whoever will be a common theme during this time of reform and hardship, thereby worsening the relationship between the people of Europe further and showing once more what a tragic, devastating and silly idea the Euro really was. God, this is depressing.

PS: The German influence is really ruinous when it comes to monetary policy, the obsession with an inadequate inflation target and the idea that the ECB’s monetary policy is highly expansionary as it is. It would be great if economists from around the world would point that out!