Posted by: Dirk | January 6, 2012

Can we trust Orphanides?

Athanasios Orphanides, member of the ECB governing council, has an article in today’s FT. He wants to dump the idea of private sector involvement:

The capacity to learn from mistakes is a hallmark of good leadership. As the existential threat to the eurozone became clearer, EU leaders changed tack. On December 9 a change in doctrine reversing the Deauville PSI innovation was announced. In future, the eurozone would adhere to International Monetary Fund principles. Leaders also agreed on a new “fiscal compact” to enhance governance.

Unfortunately, despite reversing the Deauville PSI innovation, investor trust has not been regained.

Unfortunately is not the right term, I suppose. The trouble runs deeper as most of the ECB members fail to understand the basic ideas of money and banking. Government debt can be repaid by having a government surplus, or by using the central bank to roll over existing debt, which in the process might take some debt on its own books. The idea of euro bonds builds on this insight, and other ideas like the ECB as a lender of last resort do so as well.

The ECB has proven to be independent from economic thought outside its own paradigm. It does not exhibit good leadership as it constantly fails to learn the right lessons from its own mistakes or lessons from history. Jürgen Stark warned against a transfer union when this was what was needed to regain the ‘trust’ of markets. Hyperinflation was invoked when we were close to depression, and the banking crisis of the early 1930s would have been the right lesson. When just before and during the crisis primary goods prices spiked and created some tiny, tiny inflationary pressures, the interest rate was hiked up before it was put down again. These are all policy blunders. Private sector involvement is a blunder as well, and Hank Paulson has been taught that lesson not to long ago when he bailed out Fannie Mae and Freddie Mac and let equity owners down.

‘Government debt markets are about trust.’, writes Orphanides. I agree with that notion. Investors need to trust the authorities – like the ECB – and believe that they understand finance and monetary policy. This seems like the problem that we have. If the euro is not workable, then the ECB should say so and propose reforms. Waving hands and pointing out that it should only care about inflation is a childish way to escape responsibility.

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