Last week, the FT reported the following under the headline Trichet calls for tougher Euro rules:
Eurozone members that break the region’s rules on public finances should be excluded temporarily from Europe’s political decision-making, the president of the European Central Bank has proposed.
Let me get this straight. The ECB’s president proposes to exclude countries that break the fiscal rules from political decision-making? In order to do exactly what?
Rewind: We are in the year 2007. The sub-prime bubble bursts. After some credit market wobbling, the markets tumble like dominoes. Here is a graph of what happened to the Dow Jones (DJIA):
… and here is the same graph with an arrow pointing to the outbreak of the Greek crisis:
To confirm that story, let’s look at the yield of Greek government bonds (10yr), which started to rise to levels considered dangerous only in late January 2010:
What I find rather strange here is that there is a lot of action in restraining government finances, while the financial markets were allowed to (mis)allocate freely. Just last weekend, Hypo Real Estate needed another infusion of guarantees of €40 billion from Germany tax payer – whether this money will ever be recovered is unclear. There are no statements except that politicians are surprised and angry that the transfusion was necessary.
I think it seems self-evident that the government deficits are a consequence of the crisis, and not the cause. Why, then, is the ECB so much into restraining government spending? Could it be that they have their priorities completely upside down? Imagine what would happen if sometime next year the German government starts fiscal tightening in order to obey the rules and then the European economy starts to dive again. There would be neither monetary, which does not get traction, nor fiscal policy available for decision makers … and the latter would be a purely self-inflicted pain.