Tuesday, February 11, 2014

The Legal News Kept Slipping Into The Financial Section, or You Do It To Yourself

Scott Sumner famously remarked that the worst part of reading microfilm of the 1930s financial news was the fact that "the political news kept slipping into the financial section", something echoed by Lars Christensen many times. We have long passed the point in this crisis when we should be surprised about political news slipping into the financial section, but now we have legal news slipping into the financial section - and how much more boring can it get than bothering with opinions from the German constitutional court? 

The court's swipe at the ECB's OMT has been well reported by Ambrose Evans-Pritchard. Most people appear to be missing the ramifications for monetary policy, but it seems like this is part of an even bigger story, which is a dent to the entire crisis-fighting mechanism that has been constructed since Sep 2012. That thought crossed my mind when I was reading this Aug '13 report from the Brookings Institution:

"At the present juncture, the base case of transiting into a more stable long run in the euro area seems to rely primarily on improving the incentives and control mechanisms (six-pack, two-pack, European semester, and other torture instruments). The status quo does not provide for debt restructuring (beyond Greece) and does not foresee any mutualization of debt. It relies on the Outright Monetary Transactions (OMT) of the ECB, and beyond that it is based on the hope that the adjustment process and the structural reforms that debtor countries are undergoing will eventually bring rewards in terms of higher growth. The present strategy of dealing with the legacy debt is risky since it requires an extremely long and unilateral adjustment process on the side of the high-debt countries. It could easily derail for a number of reasons—for example, if growth fails to pick up for a few more years, if the credibility of the OMT fails or if the political will to drive reform is exhausted."

Whoops. Hope, as they say, is not a strategy.

In some ways, the German court's ruling was entirely justified and utterly predictable. Mario Draghi has managed the politics of the crisis quite well - better than I would have imagined, and better than I like to give him credit for, since I'm just sitting on the sidelines taking potshots. But the risk of being a canny political operator is that people will begin to see you as such, and the German court's ruling is surely a response to the increased political role of the ECB.

The German court said it would rule on the legality of the ESM on Mar 18. As I understand them, the ESM's Primary and Secondary Market Support Facilities look similar to the OMT with the big difference that they are not conducted exclusively by the ECB, and require an MOU from the Troika. So presumably they are not as controversial as OMT. But should the German court challenge the ESM, which has already been deprived of its silent guardian (OMT), the Eurozone will have a big problem, and it may require more than the dulcet but resolute tones Mario Draghi has employed so far. 

Perhaps I'm overstating this, and European growth will pick up without ever needing the ESM, the OMT or any other arcane acronym. And let's not forget that there are forms of monetary expansion that should not be construed as QE, as Jacob Kirkegaard describes . But this all seems an awful risk for anyone to take. There have been lots of opportunities to get ahead of this crisis, but the ECB has consistently persisted in waiting till the last minute to act. There's a line in Radiohead's "Just", where Thom Yorke sings, "You do it to yourself, you do, and that's what really hurts is you do it to yourself, you do, you and no-one else." It's just human nature, I suppose, to find it harder to pity people when they seem intent on self-destruction. Unfortunately, this seems to apply to the ECB. 

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