The Corner

How About That ECB?

 You want gloom? The Sunday Telegraph’s Peter Oborne has got gloom. He’s sounding the tocsin here:

Another symptom of the frivolity of the European political class is that the European Central Bank is being urged to intervene in the Italian bond market to restore stability. Standard & Poor’s and Moody’s do not produce ratings for the ECB, but if they did, it would be given junk bond status, or worse. The ECB is bankrupt, and this would be evident for all to see but for the fact that it has grossly overvalued the practically worthless Greek, Irish and Portuguese bonds in its portfolio. At some point, eurozone states will be asked to fill the massive holes in the ECB’s balance sheet, and matters will then get messy. Some may plead poverty; others will point out that the constitution of the ECB specifically prevents it from purchasing national bonds, and that its market operations must have been ultra vires.

Furthermore, it is unclear to whom the ECB – whose dodgy accounting, reckless investments and contemptuous disregard of banking standards make even the most irresponsible Mayfair hedge fund look like a model of propriety – is ultimately accountable. The idea that it can step effectively into the Italian bond market, whose total value of around 1.8 trillion euros makes it larger by far than Greece, Portugal and Ireland combined, is a joke.

Wake up: the eurozone is very close to collapse. It will come as no surprise if some Italian and Spanish banks are forced to close their doors in the course of the next few weeks. Indeed, British holidaymakers on the Continent should be advised to take care: hold only the minimum of the local currency, and treat with especial suspicion euro notes coded Y, S and M (signifying they were printed in Greece, Italy and Portugal respectively). Take plenty of dollars with you, which shopkeepers will certainly accept if there is a run on the banks, or if euros suddenly cease to be legal currency. The precautions may not prove necessary, but there is no point in taking risks.

Alarmist? Let’s hope so. That said, Oborne’s point about the ECB is well made. There’s a lot of who-knows-what lurking on its books (we should not forget the exposure that the ECB’s short-term funding operations may have given it to the banks of the Eurozone periphery). If it was a ‘normal’ central bank that would not matter (much). A national central bank can (and should) step in and (temporarily) do what it takes—however hope, prayer and flim-flam the methods—to keep the show on the road. The distinguished 19th century political economist Walter Bagehot had this to say back on this topic in 1873 (a touch ominously I last quoted this here on the Corner back in October 2008):

A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to `this man and that man,` whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them. The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. `We lent it,` said Mr. Harman, on behalf of the Bank of England, `by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power.` After a day or two of this treatment, the entire panic subsided, and the `City` was quite calm…

…The ultimate banking reserve of a country (by whomsoever kept) is not kept out of show, but for certain essential purposes, and one of those purposes is the meeting a demand for cash caused by an alarm within the country. It is not unreasonable that our ultimate treasure in particular cases should be lent; on the contrary, we keep that treasure for the very reason that in particular cases it should be lent.

Wise words. The Eurozone’s problem is that the ECB is not a national central bank acting with the interests of a nation in mind and with access to “unlimited” resources (including, presumably, the printing press and, eventually, recourse to the taxing power of the state), but something rather more nebulous. That vagueness leaves room for the question that no one should ever want to hear in a panic of a type that appears to be building: who is going to underwrite the underwriters?

Oborne’s point is that the answer to that question is dangerously unclear. He’s right to be worried. 

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