On verge of another crisis, Geithner seeks economic stability in Europe

By Howard Schneider and Anthony Faiola
Washington Post Staff Writers
Thursday, May 27, 2010; A21

FRANKFURT -- U.S. Treasury Secretary Timothy F. Geithner dined on Wednesday night with European Central Bank President Jean-Claude Trichet, a closed-door, no-public-comment session that placed the American official in the middle of an ongoing European debate: Which Trichet would show up?

Was it the Europe-only stalwart who resisted involvement of the International Monetary Fund in a recent rescue of Greece -- and arguably slowed the process as the country slipped deeper into crisis? Or was it the quick-response pragmatist who in recent weeks tossed core principles aside so the ECB could prop up its weakest member-states?

With Europe fighting through the most serious crisis in the euro's 11-year history, the role of Trichet and the ECB have come under scrutiny by critics who argue that a series of missteps and misstatements may have made matters worse -- and continue to shake confidence in Europe's response.

That lack of confidence sent the euro falling against the dollar for the third day, to $1.2178, on Wednesday. And the unease rippled through U.S. markets, with the Dow Jones industrial average closing under 10,000 for the first time in almost four months.

Britain has not adopted the euro, but its indebtedness remains a concern -- as does that of the United States. Geithner said the budget-cutting and economic growth initiatives being announced in European capitals were important "so that people can see you're committed to follow through."

The matter is of pressing concern to Geithner as U.S., European and other leaders try to craft new global financial regulations and keep a nascent recovery on track. Geithner swung through London and Germany on Wednesday -- a detour on his way back from China -- to meet his treasury counterparts and central bank officials. His visit is part of an Obama administration effort to ensure Europe's developing economic problems don't spiral into a worldwide crisis.

"What markets want to see is action," Geithner said in London after meeting with British Chancellor of the Exchequer George Osborne and Prime Minister David Cameron.

He said a new, nearly $1 trillion fund to aid financially troubled nations and stabilize the euro "has got the right elements," but markets now needed to be convinced that European nations have the wherewithal to trim deficits and restructure their economies to renew growth that is lagging behind the United States and the rest of the world.

On Wednesday evening Geithner met with Trichet in Frankfurt, where the ECB's headquarters is graced with a statue of the currency's trademark "E," a symbol devised as a sign of Europe's budding union. The session was kept closely under wraps by both sides, with only the two men in attendance, according to aides.

The meeting came at a sensitive time for the ECB and Trichet, a 67-year-old trained engineer who is now trying to resolve some of the euro's built-in stress points. The 16 countries that share the euro have a common policy on interest rates and other monetary issues that is set by the ECB, but behave like very different nations when it comes to taxation, spending and the structure of their economies -- an arrangement recognized as a potential problem since the euro's inception.

The crisis in Greece brought that tension to the fore when its high levels of debt threatened a default, began driving down the value of the euro, and pressed the issue of whether one euro-zone country's problems should be shared by the others -- whether the ailments of a weakened economy like Greece, in this instance, would be borne by a stronger one like Germany.

Trichet, an official in the French government during that country's painful economic restructuring in the 1980s, initially thought Greece's problems were comparatively small and could be handled internally, according to a senior IMF official and others familiar with Trichet's analysis.

That was the first in a series of miscalculations that some feel have undercut both Trichet's and the ECB's standing.

In subsequent weeks he acquiesced to IMF involvement as the size of Greece's needs topped $100 billion; agreed that the ECB should continue accepting lower-quality collateral so that Greece could continue borrowing from it; and, after unnerving markets by saying the ECB would not buy the bonds of individual nations, reversed course as the central bank in essence became the continent's bond-buyer of last resort.

The slow motion nature of the Greek rescue and the uncertainty over policy as the crisis intensified sapped confidence that Europe would develop a credible response to the euro zone's larger problems of high government indebtedness and lagging growth.

Policymakers "should have realized this process was going on since the beginning of the year, and failed to provide a comprehensive solution for months and months," said Peter Bofinger, an economics professor at the University of Wurzburg and a member of Germany's advisory Council of Economic Experts.

Even the pledge of close to $1 trillion in European and IMF support for troubled European countries has failed to stop the euro's slide, as focus has turned to those larger economic problems.

"Markets are neurotic and if you see instability building you have to react in a united and comprehensive way," Bofinger said.

From Trichet's perch, however, unity could be difficult as he tries to manage a board that represents member states with widely different expectations, and that is sometimes pulled between polar demands, whether between its richer and poorer members, or between the bank's two largest capital contributors, France and Germany.

Those strains are something the Obama administration has been encouraging the Europeans to set aside in service of the larger aim of securing the global recovery. Geithner was in close contact with European officials as they crafted their emergency fund earlier this month, and announced this trip after German officials surprised their U.S. and European counterparts with an announced intent to push their own version of financial reform.

Geithner meets on Thursday with Germany's central bank head Axel Weber and finance minister Wolfgang Schauble.

The ECB was established in 1999 when the euro became the official currency of the European Monetary Union's initial 11 members. It was a carefully scripted changeover, years in the making. Conversion rates for the separate national currencies were fixed based on exchange rates as of Dec. 31, 1998. More importantly, the bank's mandate was itself a compromise, weighted to make Germany comfortable giving up the Deutschemark by adopting an almost singular focus on controlling inflation.

That has led to other clashes during Trichet's tenure -- most notably with French President Nicholas Sarkozy in 2007, who argued that the bank was keeping monetary policy too tight and stifling growth.

Now he has kindled opposition in Germany, including an open clash with Weber, who voted against allowing the ECB to buy government bonds in a rare breach of Europe's consensus-driven culture. Weber is mentioned as a possible replacement when Trichet's term ends next year, and the recent controversy has bolstered his supporters.

"The ECB has had to make a number of U-turns, and it has cost them credibility, no doubt," said Thomas Mayer, chief economist at Deutsche Bank. "Some people outside Germany would say they are pragmatic -- that they are adjusting as things move along. This is not pragmatism. It is a sign that the ECB has changed its nature."

Faiola reported from London.

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