Credit was crucial to the success of western economies in the last century and a half. Without credit, there would have been no industrial revolution, no post war recovery, and no information technology revolution either. Houses would not have been built, and shops would not have been stocked . All used borrowed money .
But it is important to reflect on what credit actually is, and means. The word credit means belief, belief that debts will be repaid, or at least that certain crucial categories of debt, like the sovereign bonds issued by the governments of developed countries, will be.
Take away belief and, literally as well as metaphorically, you have no credit.
The difficult economic situation we now face derives from the breakdown of belief in the repayability of sovereign debts of some countries, notably Greece. But repayability is not something absolute and immutable. It is an expression of human will, as well as of arithmetic.
IT ALL COMES BACK TO POLITICS
Is there a will to repay the debt of Greece, or not? That is essentially a political judgement.
But the arithmetic is also important. If the interest rate is too high, or the rate of growth in the economy and revenue is too low, even the strongest political will to repay can be overcome.
The more the markets demand a higher risk premium against the possibility that a debt will not be repaid, the higher will be the interest rate on the debt, and the more likely will be the eventuality that market participants are trying to guard themselves against, non payment. So, in a sense, the herd like behaviour of the markets, in demanding ever higher risk premia for holding Greek debt, is making more likely the very event whose consequences they are madly trying to avoid.
This is the weakness of rating agencies. They are not Olympian searchers for some objective truth. They are just mirrors, held up to the faces of panicky traders, reflecting back to them the terror in their own eyes.
ADULT SUPERVISION…THE VITAL ROLE OF THE ECB
Adult supervision of all of this has to come from outside the market, from institutions that are not driven by fear of losses ,or appetite for gain. It also has to come from outside the political market , where, in Europe’s case at least, the driving force is increasingly myopic nationalism, rather than an objective appreciation of a collective European interest.
This is why the role of the European Central Bank is crucial. It is not driven in its actions by any appetite for private gain or fear of private loss. Nor, on paper at least, is it driven by politics. Its goal, at least in part, is the preservation of a functioning credit system for the euro zone as a whole. And, in certain critical moments that requires an ability and a willingness, to print money.
THE MONEY SUPPLY….THE MISSING INGREDIENT
Why is that, despite its deficits being worse than the average of the euro zone, there have been no attacks on the sovereign bonds of the United Kingdom?
It is because the United Kingdom can print money and, in that way allow a little inflation into the system to oil the wheels of adjustment towards a more austere future.
Although the European Central Bank has stretched its mandate to the full, it is still constrained in its ability to inject money supply into the system by buying bonds ,by the narrow Treaty mandate it has been given to keep inflation at 2%, and by political pressures from some countries who are elevating an historic fear of inflation out of proportion.
TRULY EUROPEAN POLITICS IS NECESSARY IF THERE IS TO A DURABLE EUROPEAN ECONOMY
The ultimate constraint on the European Central Bank is political. There is an insufficient sense of a common European interest among the populations of the euro zone countries.
Populations were enthusiastic for Europe when it meant funds flowing from other EU countries, and secure growing markets for the goods and services they wanted to sell. But now the flow of funds is reduced and has to be spread more thinly over more members, and the markets are still secure, but they are no longer growing.
There was no underlying emotional bond, no sense that the Greeks or the Germans are “us”, not “them”. The absence of an “us” feeling among the populations of the euro zone is the problem that is now being laid bare.
It is significant that when the Governments of the EU countries came to redesign the Constitution, that had been rejected in France and the Netherlands, they dropped the Constitution’s provisions in regard to the European flag and anthem, provisions that spoke to deliberate creation of a common emotional tie between all EU citizens.
Symbolism is important and the constitutional downgrading of those symbols revealed an unhealthy contradiction between a simultaneous desire to create a common currency, and an unwillingness to demonstrate a symbolic allegiance to the entity that was embarking on that ambitious and hazardous enterprise.
We have seen where this has led. The use in recent times of the intergovernmental method, under which each member has a veto, to make key EU economic decisions has led to incoherence and delay , and has generated anger, frustration and a blame culture. We need to revert to using the traditional EU decision making method, the community method, to make the new category of decisions that the EU now has to make in the current crisis.
USE A TRULY EUROPEAN METHOD TO MAKE EUROPEAN DECISIONS
A strengthened European Commission should be central to the process. It has the capacity to forge proposals that are coherent as well as considerate of the interests of all countries, small as well as large. The inter governmental method, in contrast, leads to grandstanding and contradictory nationalistic demands.
My own belief is that the European Union needs more than a financial solution to a financial problem. To restore credit it needs to restore belief. It needs to restore belief in the European Union itself as a political project, and belief in the competence and quiet efficiency of European political institutions