With the first and second LTRO programs the ECB was able to buy precious time to allow the slower workings of politics to solve the problem structurally. Unfortunately, this placebo only worked until a Greek exit from the Euro became a likely outcome rather than a discussion theme for economists.
The excessively pro-cyclical policies imposed by the Germans and the EU on the weaker countries goes against all textbook economics, not only Keynesian. The results, deepening of recessions, deterioration of bank balance sheets, and the beginnings of social unrest, may end up provoking the opposite effects. If Greece leaves the Eurozone, it will be a signal to the markets that they should price in a Portuguese, Spanish, Italian, and who knows, maybe even French exit. That would of course mean the end of the euro.
As with all problems, the later you tackle them, the more aggressive you will need to be to hope to achieve success. Clearly the only body able to fight for the Eurozone survival is the ECB. Its next steps will have to include a strong signal, a double notch rate reduction, and a pragmatic relaxation of collateral rules. Lack of decisive action soon with these tools will only leave it the option of real QE, sometime in the summer months.
It wasn’t difficult to imagine that the Greeks would have voted with anger in their hearts. A fiscal readjustment without currency devaluation is not a pleasant experience. When people’s pensions are cut by 15-20% in nominal terms, the cohesiveness of society is at risk. The inconclusive results of that election and the standoff between a Balkanic and a European Greece are going to keep markets unsettled for another couple of months at least.
The election of the new French president that ran on the platform of ‘we can’t live on rigour alone’ is another, more core-European reaction to the same malaise. Given that Europe without France is an oxymoron, the challenge is now on Mrs Merkel to find the way to square the circle. Absent the ghosts of Weimar, a little inflation would be good for Europe, as a collective mechanism for adjusting their economies in a less painful fashion.
It is too early to tell if Mr.Hollande will be able to use his new mandate to help achieve what Mr.Monti has been arguing for some time, namely that the economies that had spent beyond their means in the good years needed to put their fiscal houses in order, but that this cannot be the only solution at a time where we are still mired in the ‘great recession’ which was initially precipitated by the 2008 banking crisis. Monti is having his own problems in Italy, where the level of taxation is near or beyond the point of diminishing returns. The next three months will be telling for the future of Europe beyond the question of whether Greece is in or out.
Next week we will know who will be responsible for running France for the next five years. If we are to believe the polls, Angela Merkel will have a new partner in the German-French axis, with which she will need to start doing business. At the next French-German-Italian summit, there will be two leaders out of three that are leaning towards a growth strategy, even if nuanced. If until now Monti has politely reminded Sarkozy and especially Merkel, that the problems that Europe is facing cannot be resolved by cuts alone, now he will be joined by an Hollande who has practically ignored the needs for fiscal prudence in his campaign, and has basically insisted on the need to keep and actually reinforce the French welfare state that costs about half of GDP.
Of course Merkel has been there and seen this already, and as the Economist reminds us, all chancellors end up ‘convincing’ French presidents over time. The problem is this time there isn’t much time, and the markets tend to like to test new paradigms or leaders sooner rather than later.