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Draghi plays a trump card

The ECB tries to find a way out of the money trap

My book argues that the euro crisis illustrates the dilemmas confronting all countries in a global economy. It is not at heart the euro but the global financial system that is the source of these dilemmas. The chances for the survival of an integrated world financial and economic system are at stake in the battle for the euro. This is illustrated by the current debate on the role of the ECB. Consider the following propositions:

To retain the benefits of economic integration, significant sharing of national sovereignty is required – and not just in the euro area. The euro is a laboratory experiment in globalisation.

It is an illusion to believe that having one’s own currency and central bank offers an escape from these dilemmas, as Anglo-Saxon commentators often allege. British performance post-crisis has been sub-par.

The fight is often presented in personal terms. Thus the survival of the euro is pictured as resting on two men and a woman – Mario Draghi, Jens Weidman and Angela Markel. Mario Draghi is portrayed as The Demon Barber of Fleet Street – luring customers into his barber shop with the offer of a clean shave only to cut their throats and deposit them in his cellar for processing into meat pies. Jens Weidman is seen as playing Thomas Becket to Merkel’s Henry II.

But the issue goes far beyond one of personalities. Draghi had to accept Weidman’s hard line. Merkel knows she must back them up. At a time of growing restlessness in Germany about the euro project, she had to. She must become “Madame Nein!”

Draghi has now played his trump card. He has made clear that the ECB is ready and willing to provide assistance – on conditions. That tough line is the only way to keep up pressure for essential reforms in weak debtor countries, and to hold out hope of a renewal of the springs of growth.

For this a total recasting of European banking and finance will be required. That is why a vision of a new banking system for Europe is essential.

With structural reforms and a banking union assistance will be provided. This is rational, since only then will private capital also start to flow back to debtor countries. Only such private sector commitment can provide the basis for balanced growth.

To provide assistance now without reforms – for example, for the ECB to bring down Spanish yields by buying Spanish government bonds – would simply let governments off the hook.

It is a political matter whether debtor governments can push through the reforms needed to qualify for external aid or attract private capital inflows to finance their payments deficits – or on the creditors side whether they can extend further assistance.

The ECB should use the same approach as the IMF in dealing with countries in deficit, and use similar techniques, applying appropriate conditionality, so to to keep the pressure on governments.

This is apparently also in line with what the people of the eurozone want; growth with continued membership in the eurozone.

The ECB’s actions and attitude should reflect that key collective commitment to the euro. It is not, as British commentators so often say, a question of whether this or that country in its short term interests would do better outside the euro or not. (That is a typically British shop-keepers’ perspective and explains why the UK cannot and should not join).

What matters is that membership facilitates in the long term public acceptance of the measures needed to survive in an integrated economic and financial system. That could be one way out of the money trap.