James Saft, Reuters Columnist
In this case the elephant the ECB is being called upon to shoot is the market, which is once again trampling down hopes that the euro zone will get a sustained respite from bailout and break-up fears. Spanish government bond yields broke above the critical 6 percent mark on Monday, and now stand well above where they were before the ECB’s unlimited LTRO financing offers in December and February.
That puts all eyes squarely back on the ECB, as perhaps the only institution with the power, if not the right or the inclination, to wade into markets and drive Spanish yields back into sustainable territory and avoid a bailout of Spain. While there might be money out there to fund Spain’s rescue, it would, like the rescue of Greece before it, only raise questions that make a spreading round of panic followed by bailout more likely.
Will the ECB act anyway if things become difficult enough? Probably – they have a track record of coming in a bit weak and a bit late, and it’s likely they will follow suit in 2012. The irony is that the only sure beneficiary will be speculators, who will take their share as yields rise and fall
This is all likely to be causing agony within the ECB. Its bond buying program in 2011 did not work well, not least because it was so obviously divisive within the central bank. You can easily argue that rescuing member states in fiscal difficulties by spending euros to buy their bonds is outside the ECB’s remit, which is narrower by treaty than that of the Federal Reserve or Bank of England. You can also argue, convincingly, that doing so is a dead end and a distraction.
Spain needs either devaluation - impossible if it stays within the euro - or a rather large transfer of funds, essentially from Germany. The price of that transfer, or the promise of it, seems to be a program of austerity. That seems to be working as well as lighting your sleeping bag on fire as a way to stay warm at night.
Orwellian choice
So, as news of Spain’s woes continues to dribble out, the pressure will mount on the ECB to ’do something’ to bring markets to heel.
The ECB’s position is in some ways reminiscent of that of the protagonist of George Orwell’s essay “Shooting an Elephant” about his experiences as a young British colonial policeman working in Burma in the 1920s.
Orwell is called out to “do something” about a tame elephant which has gone temporarily berserk, as they sometimes for a time do, trampling market stalls and killing a man. By the time he reaches it, the elephant seems to have calmed down, but Orwell, with the eyes of the crowd on him, some of whom like a show and some of whom just want meat, feels intense pressure to act.
Simply not to look stupid and also because the crowd, even though it resented him as colonial overlord, expected him to do something decisive, he shoots and kills the animal, a pointless and destructive act.
Orwell’s point, in part, was that, though he had the gun and the position, the power was not his alone.
The ECB, like Orwell’s junior colonial officer, is trapped; forced by the expectations of others into doing something it thinks likely to be wrong and futile. Wrong because it is against the spirit of its governing agreements and futile because it fails to address Spain’s weaknesses and the limits of the euro zone as it is now constituted.
This is not to say the ECB’s position within the euro zone doesn’t need reform. The currency area quite obviously does need a fully powered central bank but it doesn’t have one in part because its other institutional arrangements reserve fiscal powers to the individual states which will inevitably leave the ECB again some day in an impossible position.
Will the ECB act anyway if things become difficult enough? Probably – they have a track record of coming in a bit weak and a bit late, and it’s likely they will follow suit in 2012. The irony is that the only sure beneficiary will be speculators, who will take their share as yields rise and fall.
That the LTRO, a very low-cost loan to banks with which to buy government debt, has only had an effective half-life of a couple of months should give the ECB serious pause. It illustrates the essential difference in the crisis: between liquidity and solvency.
The ECB will shoot its elephant, but it’s the wrong act, using the wrong tools, addressing the wrong problem.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)