Monday 25 March 2019

ECB won't go nuclear if we default on promissory note – look at Greece

THE ECB never does anything without an eye on global trends. In the overall scheme of things, despite the fact that it's the "European" central bank, things that happen in small European countries matter little in setting the tone. In contrast, what happens in big countries, with competing currencies to the euro, matters a lot.

When it comes to small European countries, the ECB's tactics are always the same: threats, nasty leaks, warnings of Armageddon, and orchestrated press releases, all followed by a well-disguised climbdown. Expect the same here.

The reason for this is that the ECB has no conventional weapons but it does have the nuclear option: when a country can't pay its debts, the ECB can cut off the banking system from ECB financing. This brings the country down, which will cause chaos not just for that nation but, via contagion, for the whole euro system. So the ECB is condemned to climb down. The best example is Greece – it's a four-time defaulter within the euro, and yet money still comes out of its ATM machines in Athens.

But all the while, the ECB is more worried about what is happening in Japan then either Ireland or Greece.

In blunt terms, the independence of the Japanese central bank is over. The government has decided it's time to generate inflation, time to let the yen fall and kick-start the economy via debasing the currency. Japan announced this once-in-a- generation policy change two weeks ago.

Having independent inflation hawks running how much money is printed is great in inflationary times, but absolutely stupid in deflationary times. Japan's recession has blown the old orthodoxy apart. When the problem is deflation, the solution is inflation. When the problem is falling prices, the solution is rising prices.

The people who are at the top of the ECB are driven by the mantra of "stable or low prices good, rising prices bad" but they also know that there is a finite time within which to indulge their deflationary fantasies.

One of the reasons Japan could suffer two decades of low growth, low incomes, falling prices and higher and higher taxes, is that the population is homogeneous. Europe is not. It is a multi-ethnic society with social welfare spending which is likely to fracture into racial conflict as the already huge levels of youth unemployment, which are much higher in immigrant communities, continue unchecked.

As Angela Merkel observed at Davos, Europe has 7pc of the world's population and produces 25pc of global GDP but finances 50pc of global welfare payments. This can't last without growth.

Europe and the European project can't survive a decade of deflation. The first thing to go when politicians know they have to reflate the economy is central bank independence. Therefore, with money being printed everywhere and currencies such as the yen, the dollar and sterling involved in competitive devaluations, the ECB's ideology is hardening today to protect itself from political interference tomorrow.

Therefore, Ireland is caught in the teeth of an ideological battle for the future of central banking, which is why what happens in Tokyo is much more important than anything Irish politicians say.

Regardless of the members on the ECB's board, at the top of the ECB there is the pragmatist Mario Draghi. He knows that he has no conventional weapons to threaten Ireland. He also knows that nuking the poster boy is hardly a clever way of keeping order in the euro classroom, so he makes threats via his underlings, who pass this on to our civil servants, who brief our politicians, who end up saying silly things in public like: "There will be no cash in the ATMs".

But there will be cash in the ATMs. Look at Greece. If any country "deserved" to have its flow of cash cut off, it surely must be Greece. Having defaulted at every opportunity, having slashed its debt burden through defaults, having given the two fingers to everyone, surely the ECB would eventually cut off funding to the Greek banks. Has it done this? Has it f***!

The Greeks understand the basic rule of monetary economics: the lender of last resort, the central bank, exists to be defaulted on. It prints the money, so it can't go bust.

The Greeks and the ECB both understand that money is politics and politics is money. Our politicians are repeating mantras given to them by the ECB's spokespeople and these politicians in turn feed this to certain journalists, who come out with things like, "we must respect the ECB's independence" or "these things are very complex". Get a grip.

The ECB was created by politicians. It will be brought to heel by politicians. That is what democracies do. The last time we had independent central bankers try to threaten social peace in an era of deflation and high unemployment, central bankers lost. That was the Great Depression and the Gold Standard. The lessons are there for anyone with a grasp of history.

This brings us to the promissory note. We know that keeping a dead bank alive with real money makes no sense, but we are told that the consequences of not paying the money will be dire. But what are they, these consequences?

Here I write as a former central banker, and I can tell you the consequences are likely to be minimal. We know the ECB won't push the little red button and detonate the nuclear option. It didn't do that in Greece. It knows failure in Ireland will bring the Japanese solution closer, so that will be avoided at all costs. ATMs will continue to work. Life will go on and if you believe that the Irish State will be around in one hundred thousand years or one million years, we will pay back the promissory note in installments of €30,000 a year. We would still be paying it. We would have simply adjusted the terms of the IOU. There are all sorts of things we can do because the IOU is one part of the Irish State paying back another one, so who cares? Yes, of course it's monetary financing, but this is what you do in deflationary times, with unemployment at close to 15pc, emigration rampant and GNP down almost a quarter in six years.

The ECB is in a bind, not us.

Seamus Mallon famously said of the Belfast Agreement that "Republicans are too clever to admit they've lost and Unionists too stupid to see they've won". With regard to the promissory note, the ECB is too clever to admit that it might lose and Irish politicians are too stupid to see that we could win.

Irish Independent

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