The world press almost universally condemns Angela Merkel for not approving unlimited ECB bonds or other equivalent solutions to the “European problem.” This article explains why the world press is wrong about Angela Merkel´s opinions.
The implicit assumption of the world press is that unlimited guarantees or bonds from the European Central Bank will solve the problems in Europe. This view rests upon the assumption that the problem is “fear” of the bonds not being paid is driving interest rates paid to unsustainable levels for the debtor countries. The idea is that the Southern European countries can work their way out of the problem if interest rates are kept low. The concept is incorrect and will not work.
The correct concern must be that sovereign debt will not be paid even if they get the ECB bonds. All bankers who manage workouts know that just giving your customer more money, infinitely deferring payments, etc. does not fix a credit problem. Your customer must have a viable plan to repay the money he owes. Greece and Portugal do not have viable, socially acceptable plans to work their way out of the problem. There is concern whether Italy and Spain can work their way out, although they have a much greater prospect of working their way out of the problem.
With the sure problem of Greece and Portugal, and complications in Spain and Italy, there is going to be a Southern European commercial banking collapse, with or without the ECB bonds. The only difference is that the ECB bonds will defer the problem for a year or so. This ECB temporary solution will generate much greater uncollectable debt. The first source of payment is by printing money, with the unfortunate consequence of creating an unwanted, devalued euro. The second source of payment can be Germany, with the unfortunate consequence of effectively bankrupting Germany. Neither of these outcomes makes sense long term for Europe or Germany.
This scenario is explained in this recent article of mine. Whether today or a year from now, the inevitable outcome is that several Southern European countries will not be able or willing to pay their debts, particularly given the painful social costs. Some Southern European countries will prefer default to making the necessary social adjustments. The problem will explode at the level of the commercial banks, which are now starting to see flight capital. Between the sovereign debt problems and the loss of commercial bank deposits necessary to continue normal operations of the Southern European banks, we will necessarily see a collapse of much of the banks of the Southern European nations. As a result of Southern European bank failures, many of the Northern European banks will also fail because of their loans to the Southern European banks.
It is commonly said that the worst thing that can happen is that Europe prints the money to pay off the bonds and that will cause "some" inflation. But inflation inevitably brings devaluation of the currency. Dollar based American banks will not want to lend a hard currency to a borrower dealing in currencies likely to be devalued. Even European banks will not want to invest in bonds likely to be devalued. The bottom line is that bailing out the European banks and countries with the ECB is ultimately condemned to failure because the debtors do not have the capacity to repay their debts in a hard currency. The current situation of Greece compares directly with lending to Argentina over the last 50 years.
In summary, Angel Merkel is right to not guarantee the ECB bonds for two powerful reasons. First, several Southern European countries will not be able or willing to make the necessary economic adjustments and will inevitably default on their sovereign debt. The default of even one or two countries will have the effect of first causing big losses to the Southern European commercial bank lenders, which in turn will affect the solvency of the Northern or US banks that lent to the Southern European banks. The bond issue ignores the true problem to be fixed: the real problem is the lack of liquidity, and therefore the solvency of the European commercial banking system. The issuance of ECB bonds will not solve the coming collapse of Southern European banks. Furthermore, if Germany is ultimately going to pay the debts of the Southern European countries, these countries simply will have no motivation to make the necessary social sacrifice. “Let Germany pay” will be the byword of the Southern European countries. Therefore, if Germany agrees to guarantee the ECB bonds, it will end up in a year or so just as broke as the current Southern European countries and have achieved nothing for Germany or even Europe. If Germany and France do not guarantee the ECB bonds, the ECB bonds will not be salable at low rates of interest and thereby accomplish nothing.
The second powerful reason not to issue or guarantee the ECB bonds is that Germany will not go broke if it does not guarantee the bonds. But much of the Southern European countries will go broke with or without the ECB bonds. Yes, Germany will lose business for a number of years with much of Europe going broke, but it can buy Southern European assets for 30 cents on the dollar and end up as the owner of much of Europe. And if Germany does not buy, there will be plenty of Asian countries ready to buy the European assets on the cheap.
In conclusion, Germany should not issue the bonds because several Southern countries do not have the ability or social will to fix their problems inside the eurozone. Why should Germany put itself in bankruptcy guaranteeing countries that do not have the ability or political will to repay their debts? Furthermore, Germany will emerge whole and profoundly strong economically after a European bankruptcy (even though German banks will be hurt badly), giving it the ability to buy up major businesses throughout Europe after the inevitable happens.
A word of advice: Listen to what Angela Merkel says and not to what everyone one else believes or wants to be the case. She has said clearly no ECB guarantees until reform of European relations, which will take more than a year. This might well be a very subtle way to say “No” to what most people erroneously want for Europe. It may well turn out that Angela Merkel is the most important determinant of what happens in Europe.
Inevitably there will be a collapse of the European commercial banking system, with the greatest damage in the Southern countries and severe damage in the Northern European countries. This will be a part of a world wide problem that will last for several years and greatly affect world wide equity, commodity and bond markets.