LAST UPDATE: With the Italian and Spanish bond yield spiraling out of control crossroads for the EU will be reached pretty soon. The only choices left are all bad - they will have to choose the least bad. This article puts the choices that confronts the EU very clearly Why Europe's Central Bank May End Up Printing Money or face a disintegration of the Eurozone. The Italian govt needs to maintain a budget surplus of 5% just to maintain its debt level - this is not going to happen. With bond investors demanding close to 7% yield on Italian bonds, Italy's debt burden will escalate and default become mathematically inevitable unless the ECB intervenes. As the indecisive leadership in Europe does the "wait and see", France, the 2nd largest European economy faces a downgrade of its debt and substantially higher financing cost destabilising the entire EU. Germany itself depends mostly on its neighbors to buy its exports Unless their plan is to simply refuse to allow the ECB to print money at all cost and take immense pain of a recession (some say depression) that comes, it make sense to act early - if they wait to be forced by the markets, like the 2008 financial crisis, the consequences will be terrible when the situation spiral out of control. If they simply refuse to do it (print money), they have to be prepared to watch their economy sink and the EU breakup. Going back to my original article, I was perhaps too optimistic that European leaders will act to arrest a predictable deterioration of the situation ....this crisis has gone on and on for 2 years, they do something when they are forced to do it and never got ahead of the problem. This is almost the best time for the Germans to nod their head and just get it done, their neighbors have been been punished enough by austerity, social unrest and collapsed govt - the issue of moral hazard is no longer there. But yet we see a George Bush in Merkel, Bush held out ideologically a "no bailout" until Lehman collapsed and he was forced to bail out everyone. Merkel confronts a situation that is similar and a "no-printing money" ideology resulting from bad German memories from the Weimar Republic hyperinflation ...but the situation is completely different now and the consequences of not acting will be devastating for EU and perhaps the rest of the world....Here's an interesting article by Jim Jubak on Germany’s Support Withers as Euro Panic Worsens. He wonders how long Merkel can hold out as pressure mounts on the ECB to do something.
FURTHER UPDATE: A few commenters correctly pointed out that ECB is bounded by rules of the EU treaty not to print money. The rule is in place to avoid moral hazard. However, the ECB has been buying sovereign bonds to contain the crisis but in a limited manner to keep sovereign debt interst rates from spiking up. The question whether ECB will be a lender of the last resort and use a "wall of money" to end this crisis or keep intervening in the secondary market until "something happens". If the situation spirals out of control, the EU itself will disintegrate so that is incentive for the ECB to act. There is a fuller discussion of all the options for the EU here : Waiting for deus ex ECB by James Saft. Relooking at all the information, I have to admit my original posting is too optimistic and naive. The stock market, currency market and bond market appeared to have taken different positions on Europe : Stock Making a risky bet on ECB printing money....the writer wisely points out there is no coherent or consistent view of how the situation will develop which explains the volatility we are seeing. If we go back to the prophetic book "Debt and Delusion" written in the 1990s, monetizing debt (printing money) is the least bad of all the bad options that confront a country that cannot pay its debts - so we see countries like US, UK, Japan printing to pay its debts. Some believe it is the most likely outcome for the EU and the question is when not whether they will do it.: Will The ECB Print Money? The Key Question For European Debt Crisis
UPDATE: After I made my posting, an article appeared in Globe and Mail exploring the same idea with some figures to show that it is feasible [:ECB could bail out Italy in a jiffy]. It shows that if the ECB is willing to print money at the same scale as the Bank of England, it will be able not only to cover Italy's budget deficit but its entire budget for they year and Italy would not need to go to the debt market at all for one whole year instantly defusing the crisis. The UK central bank has already printed £275B and it did not cause price instability there..
I've been watching the doom and gloom predictions of pundits on TV quite closely. These dire predictions include that of a 'Lehman moment' for the current crisis that describes a sudden catastrophic financial failure of a country or a major bank with reverberations reaching to every corner of the financial world. I also hear talking heads criticising Europe for the lack of leadership in particular the Germans (Angela Merkel) for failing to quickly defuse the crisis. My view of things are rather different. I actually believe the German leadership knows exactly what it is doing and is getting what it wants from everybody. ...let me explain....Lets start with a few questions and answers...
Which is the most indebted developed nation in the world? The answer is not Greece but Japan. In fact Japan has double the debt to GDP compared with Greece How come Japan is not in crisis like Europe or Greece? Japan is able to borrow money cheaply at 2% interest. What about USA? USA is also a highly indebted nation but investors are flocking to buy US treasuries (US debt) and they can't seem to get enough of it driving 30 yr US treasuries to the lowest interest rate in history. US is deep in debt but creditors are very eager to lend it money. Spain collapsed and needed a bailout very early on in the crisis at a point in time when its debt to GDP was smaller than that of Britain. Creditors did not want to lend money to Spain but are more than willing to lend to Britain. Why?
The answer to all the above question is Japan, Britain and US owe a debt denominated in its own currency so they can print as much money as they need to pay their creditors so it is not possible for these countries to default. During the Asian crisis, Thailand had a debt denominated in US$ so when the baht fell against the US$ it collapsed quickly because it could find enough US$ to pay its creditors. So the main difference between countries in trouble and those that are not is not the size of the debt but whether they are able to print money to pay down their debts.
How come the ECB (European Central Bank) did not print Euros and print its way out of the crisis? They were trying to at some point but the Germans opposed to it. Printing money has this effect of stealing a bit of money from everyone in the Eurozone (by way of inflation) and it is unfair for the Germans who have kept their deficits small by cutting entitlements for its citizens.Printing money to bailout these nations will result in a moral hazard ...these countries have to learn some important and painful lessons. So instead of printing money which was a relatively easy thing to do, the Europeans orgainsed a massive bailout package known as ESFS [Link]. If a financially troubled nation wants money from the ESFS, it has to play ball by implementing harsh austerity measures and promises to cut deficits something these countries refused to do before the crisis.. The Germans got what they wanted out of these spend-thrift nations using the ESFS as a big stick. Without ESFS money, these countries would have to default on their loans and the govt would collapse instantly because they have no money to keep the govt going.
With the political leaders in Greece and Italy thrown out and replaced by technocrats who previously worked in the ECB and EC, they will quickly pushed through budget cuts and austerity in the respective countries. Creditors who lent to Greece have been punished with a 50% haircut on the amount they loaned.
Now with every one who misbehaved painfully punished, I believe the ECB will start printing money and buying sovereign debt of troubled European nations. It had done so intermittently in the past but have just declared they print money and buy all the sovereign bonds they need to buy to stabilise the situation [ECB bond buys will go as far as needed: Kranjec], The Germans will not stop the ECB at this point because they have already gotten what they want in terms of austerity and fiscal discipline from nations that caused the crisis. Germany is highly dependent on these countries to buy their exports and cannot have the situation deteriorate. Printing money and buying bonds is an incremental process that does not affect significantly price stability (cause massive inflation) in the short term....it pushes the interest rate down and gives the ESFS more "bang for the buck" instead of giving high returns to creditors.
In short, despite what we see on TV and read in the news papers and our Prime Minister urging European leaders to put in more effort to "avert a global meltdown" (Focus on euro zone crisis, avert global meltdown: PM).....I believe the crisis has already ended. While there may be sudden kneejerk of financial markets reacting to various news from Europe, the worse part of the crisis, I believe, is behind us. The problems in Europe are long term in nature and will be morph from a crisis to a graceful degradation...they will can and keep kicking the can down the road spreading their financial problems over time..