Is the Euro Crisis Coming Back?

The ECB hastily convened an emergency meeting today. An urgent solution had to be found to 'save' the heavily indebted Italy - which is particularly problematic given the currently high inflation rate. A solution was found, but it only exacerbates the problem. Heavily indebted states are facilitated in accumulating more debt, while more solid states are burdened. Further measures will likely be necessary.

The European Central Bank (ECB) is the central bank of the Eurozone. After convening for an emergency meeting today, one might also say it is a 'crisis bank.' Because the Eurozone is creaking violently again, and memories of the sovereign debt and euro crisis from 2010 to 2013 are coming back.

Let us remember: Several, especially Southern European countries, were so heavily indebted in 2010 that sovereign defaults were feared. Private investors consequently parted with the government bonds of the crisis-ridden states (mostly from Southern Europe).

There were many sellers, but far fewer buyers. So prices fell, and interest rates rose. Rising interest rates worsened the situation for the crisis states, as their costs for new debt increased. In the more solid Eurozone countries, however, the situation was exactly the opposite, as a good portion of the fleeing capital was invested in safe German or Dutch securities. A similar situation is emerging today.

The ECB bought bonds that no one else wanted

Back then, even some hastily set up rescue umbrellas could not manage the situation: The Eurozone was drifting apart. Until the ECB decided in 2015 that it would buy the bonds for which there were no buyers. Furthermore: Because it would be problematic if the ECB selectively protected individual states, it decided that it would not only buy bonds from the crisis states but across the Eurozone in an unprecedented manner. So much that interest rates fell everywhere, sometimes even into negative territory.

As of today, the ECB has purchased more than 4.4 trillion euros in government bonds. This is far more than double the total amount of debt that has been piled up from all federal budgets since 1949. And the kicker is: The ECB can print the money for these purchases itself. The more it buys, the more money it brings into circulation.

The debts of Southern European states are now higher than before

Where lies the problem? There are actually two problems. The first is called inflation - more on that below. The second is called debt: The overindebtedness of the Southern Eurozone states was only seemingly alleviated by the ECB. In fact, the debts of the Mediterranean states (and some others in the Eurozone) are now higher (!) than at the beginning of the sovereign debt crisis. Both absolutely and relatively to GDP.

It is no surprise: The ECB rescued the overindebted states. It believed it had to save them to protect the euro. Thus, the ECB also issued an invitation to take on new debt: The higher the debts of the crisis states, the more endangered the euro is. Thus, debtors can confidently expect to be rescued again.

Those who do not believe this should listen to ECB director Isabel Schnabel. Last Tuesday, she spoke in Paris about the new signs of crisis: The ECB's commitment to the euro knows no bounds. She is clearly echoing Mario Draghi's 'Whatever it takes...'. Therefore, one did not even need to wait for today’s emergency meeting of the ECB to know where things are headed: The ECB will buy even more debt instruments from the crisis states.

Inflation was zero percent in 2015

However, there is a catch: We now have 8% inflation. That was different in 2015. Back then, inflation was zero percent. Naive minds call this price stability, but the ECB, the guardian of price stability, aimed for just under 2% inflation. In 2015, the massive purchase of government bonds thus still had a pleasant side effect: Because the ECB wanted to raise the inflation rate anyway.

However, this did not work out initially. Despite the flood of freshly printed money, inflation in the Eurozone remained at a very low level for several years. And when it finally rose, it did not care much about the ECB's 2% target.

So today we have 8% inflation, and therefore the ECB should not further inflate the money supply through securities purchases. On the other hand, the ECB wants to buy Southern European government bonds to dampen the interest rate increases there. What to do?

The ECB wants to save the euro with decisions made at an emergency meeting

This was the purpose of today’s emergency meeting. A compromise was decided. The ECB already has plenty of government bonds, and some bonds regularly reach maturity: they are repaid. The ECB wants to use this opportunity to shift from German government bonds to Italian securities.

In principle, it works like this: If in the future the Federal Republic of Germany pays off a German bond, the ECB will buy an Italian government bond for the money. The money supply thus remains the same, but interest rates rise in Germany and fall in Italy. For Germany, government debt becomes more expensive, and for Italy, it becomes cheaper. Always in comparison to a situation without ECB interventions.

The heavily indebted Italy can incur more debt in the future even more easily

This seems absurd. Italy is heavily indebted, Germany is not. Nevertheless, the ECB's decision today facilitates Italy's borrowing - and makes it harder for Germany. And the more indebted Italy becomes, the more vulnerable the ECB is. Because if Italy can no longer service its debts, then the euro could fail. But since - according to Ms. Schnabel - the ECB's commitment to the euro knows no bounds, Italy knows it will be rescued indefinitely. So it need not shy away from debt.

By the way, this shifting within the 4.4 trillion euros in government bonds is apparently not sufficient at all. At least not in the eyes of the ECB. Because the ECB also decided today to 'accelerate the completion of a new crisis instrument.' There seems to be urgency at our crisis bank. What exactly it has in mind is not yet known, but it can only lead to the conclusion that the ECB will buy government bonds from Southern European states on an even larger scale.

The ECB is extinguishing the fire with kindling

This way, the ECB loses its independence. More precisely: It has already lost it. It is becoming more and more the creditor of states that could no longer service their government debts at normal interest rates. Therefore, the ECB must artificially reduce the interest rates of these states. But in this way, the ECB is extinguishing a fire with kindling. The debt crisis will only be exacerbated in the medium term. And this has little to do with the ECB's actual mandate, which is to maintain price stability.

https://www.cicero.de/wirtschaft/notsitzung-europaische-zentralbank-ezb-italien-schulden-euro