Betting on European economic incompetence has been a one-way trade for two years now. If you assume the Europeans won’t deliver on their promised solutions, then you make money. A supposedly smart guy named Jon Corzine, the former head of Goldman Sachs, wagered last year that European bonds would find a bottom and recover. Wrong. His firm, MF Global, is now bankrupt.
We’ll know that Europe is emerging from its mess the moment that bearish traders get caught going the wrong way. The euro-pessimists should be modestly nervous that the new Greek prime minister, Lucas Papademos, is a former central banker who understands economics, and that the new head of the European Central Bank, Mario Draghi, is also savvy about financial markets.
But until the political leadership of core Europe — and that really means German Chancellor Angela Merkel — is prepared to create a eurozone that convincingly guarantees the “full faith and credit” of its members, this circus will continue.
Merkel has chosen, at each turn, a course that is doomed to fail. She extends bailouts to the busted economies at the periphery of Europe, such as Greece, but only with severe austerity measures to show German voters that the bad countries are paying for their sinful ways. To nobody’s surprise, this technique of bleeding the patient makes him only sicker.
As Martin Wolf noted in the Financial Times last week, the Germans would be wiser to encourage aggressive monetary easing across the eurozone, so that everyone can grow out of the crisis; if the Germans can’t bear the inflationary risk of such an expansionary policy, then they should cut the Greeks loose and let them adjust on their own through a flexible drachma. Staying in the middle of this road, with Merkel rescuing and punishing at once, is the wrong place to be.
The Europeans advertise their inability to make good policy and stick by it. A decision taken in June 2010 to create a bailout fund called the European Financial Stability Facility still has not been fully implemented; this month’s calls at the Cannes summit for coordinated global rescue efforts were empty, because they lacked support from China — and from Germany itself. Merkel, for example, has rejected recommendations for a $3.1 trillion debt repayment fund that might contain the damage.
Contrast the European indecision with U.S. policies, coordinated between the Federal Reserve and the Treasury departments of the Bush and Obama administrations. As former president Bill Clinton explains in “Back to Work,” a book published last week, “the meltdown did not become a full-scale depression because the government acted to save the financial system from collapse.” The Fed spent $1.2 trillion to guarantee banks and buy securities. To take bad assets off the books of financial institutions, Congress voted to authorize $700 billion for the Troubled Asset Relief Program (TARP).
Americans hated TARP, but guess what? These measures worked to stabilize a financial system that was going off a cliff. Fed Chairman Ben Bernanke and Treasury secretaries Hank Paulson and Tim Geithner are sometimes cast as villains in the American drama — but Europe should be so lucky.
“From the very beginning of the global crisis, there has been a reluctance by governments to face up to the underlying solvency problems,” argued Mervyn King, the governor of the Bank of England, in a speech last month. The Europeans buy time by injecting liquidity into the system, but they don’t address the underlying solvency problem in the way that the TARP program and the Fed’s special efforts did.
Europe today resembles the United States under the Articles of Confederation of 1777, which defined our union until the Constitution created a more centralized government in 1789. Even then, it took much of the 19th century for America to decide what kind of a central bank it wanted.
Europe today is stuck in between. The problem is that, in a global economy, we are all stuck there with them.