In the Clear?

by Andrew Stuttaford

Draghi’s plan for bond buying by the ECB in the primary markets (‘Outright Monetary Transactions,’ to use the lovely jargon) has significantly reduced (for now) the risk of an involuntary exit of any of the euro zone’s weaker brethren (although Greece still teeters uncomfortably near the edge), taking bond yields down with it, but, as the Daily Telegraph’s Roger Bootle reminds us, it’s too soon to pack the fat lady off to the spa:

In several member countries, government finances are perilously weak. But worse than this, their economies show next to no economic growth, or are even contracting. While this continues, their debt ratios will continue to rise.

Yet their costs are stranded way above a competitive level. Consequently, they cannot overcome their problems by increasing net exports. The classic IMF cure always involved doses of austerity combined with devaluation in order to deliver an export boost to demand. European politicians have administered the first part of this treatment but the euro has prevented the second.

Still, what cannot be sustained won’t be. It is usually unclear, though, where the fatal blow will fall….

Meanwhile, if bond buying is to be sanctioned, the relevant countries have first to apply for assistance. This is not a done deal. If they apply, they must agree to abide by conditions which imply a humiliating loss of sovereignty and yet more austerity.

Bootle goes on to list various potential political problems looming on the horizon, including the return of Berlusconi to power (I doubt it, although keep an eye on what his former finance minister Tremonti is up to) and the secession of Catalonia and the Basques from Spain (again, I doubt it), but Bootle’s twist on the prospects for Greece (teetering on the edge, remember?) is intriguing:

Meanwhile, the Greek economic situation has deteriorated and, surprise, surprise, Greece has not been able to stick to the conditions laid down in the latest bailout. It will soon need another. Yet last week the German finance minister said that there will not be a third Greek bailout. In that case, how will Greece manage? We are moving close to the point where Greece is asked to leave the euro, or it sees no alternative but to depart.

All along, the euro authorities have worried about the possible financial contagion from such an event. With the Draghi scheme in place, however, if a Greek exit were followed by an attack on other peripheral bond markets then it would be met by potentially “unlimited” purchases by the ECB. And that prospect should deter the attack. This knowledge should give the euro authorities confidence in facing up to Greece. Perhaps the real significance of the Draghi plan is to make a Greek exit more likely and more imminent.

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