By Edward Hugh
This post first appeared on my Roubini Global EconoMonitor Blog “Don’t Shoot The Messenger“.
The version in question is an interview with the Financial Times. A summary was available here, but now they have gone live with the whole interview. If you can raise it on Google or something then it is well worth a read. For one thing it will offer you a trip down memory lane. Anyone remember this?
“If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.”
The reference is, of course, to former U.S. Treasury Secretary Henry Paulson, who famously used the remark in 2008 congressional testimony. But as Republican Senator Bob Corker pointed out in a subsequent hearing:
“I do want to remind you that the theory behind the bazooka was that if you have a bazooka in your pocket and the markets know that you have it, you will never have to use it. I would like to point out that you not only pulled it out of your pocket and used it, huge amounts of ammunition was pulled out of the taxpayer arsenal to solve that. I think you’ve done some very deft things and I compliment you on that, but the point is that things don’t always work out the way people, in their best efforts, think they’re going to work out.”
Well, the idea just surfaced again, this time from the lips of Mario Monti:
“I’m convinced, and the IMF is also convinced, that the more pledges are made [to the rescue fund], the higher the volume of pledges made, the smaller the probability that a single euro of cash will have to be disbursed.”
But, as former IMF Chief Economist Simon Johnson once explained, the latest version of the “bazooka” is unlikely to be any more successful than the previous one.
“Today’s proposed bazookas are about providing enough financial firepower so that troubled European governments do not necessarily have to fund themselves in panicked private markets. The reasoning is that if an official backstop is at hand, investors’ fears would abate and governments would be able to sell bonds at reasonable interest rates again. This idea is just as dubious as Paulson’s original notion. Markets are so thoroughly rattled that if a financial backstop is put in place, it would need to be used — probably to the tune of trillions of euros of European debt purchases from sovereigns and banks in coming months. Whether or not it is used, a plausible bazooka would need to be huge.”
Fortunately the ECB has deep pockets, and as I argue in this post, these will probably suffice to keep short term bond yields down to acceptable levels, and help the banks fund themselves and recapitalise. What the ECB’s LTRO’s won’t do is get new credit moving (one significant part of the initiative involves banks in the troubled periphery economies not having to write down the asset side too much too quickly, so there will be little room for “creative destruction”). As fund managers Bridgewater put it recently:
“We believe that a) there are logical limitations to the amounts of debt that creditors will choose to lend to debtors, b) at this time numerous debtors have passed their limits, and c) the projected rates of adjustment that policy makers are using, which generally mean slightly slower rates of increase in indebtedness rather than debt reductions, cannot happen. In other words, despite attempts of policy makers to push this debt expansion further, they can’t. Significant funding gaps will remain……. understandably, central banks are now trying to fill the funding gaps with abundant liquidity. At the same time, banks must contract and consolidate as they can’t adequately recapitalize.”
Leaving aside the tricky issue of the extent to which the latest Euro management initiative will work, Monti does have more interesting things to say. He is, for example, quite positive about Standard and Poor’s:
“If I ever dictated anything, it must have been what S&P had to say about domestic Italian economic policy,” he chuckles, before quickly correcting himself: “I never said the three letters BBB,” a reference to Italy’s new S&P rating of triple B plus……..“It’s very interesting when they go through the various factors, and concerning the political risk factor they say there is one negative: ‘The European policymaking and political institutions, with which Italy is closely integrated’,” he says. “And then they go on, saying, ‘Nevertheless, we have not changed our political risk score for Italy. We believe that the weakening policy environment at European level is to a certain degree offset by a strong domestic Italian capacity’. “I think I’m the only one in Europe not to have criticised the rating agencies,” Mr Monti boasts.”
As Peter Spiegel and Guy Dinmore not unreasonably conclude, the reason for this positive tone is clear: “Mr Monti’s 60 days in office have been enough to convince the agency that his government is on a path of reform that could return the country to growth and shrink its debt levels, but that European Union mismanagement of the eurozone debt crisis is dragging down struggling countries, including Italy with its €1,900bn ($2,400bn) debt mountain”.
“Over the course of the 90-minute interview, Mr Monti is careful not to challenge his counterparts directly. Asked whether the S&P analysis is a condemnation of Ms Merkel, who is widely viewed as the driver of the current response to the eurozone crisis, he is diplomatic: “I don’t think we can really single out one country or one person,” he says. Later on, when asked how concerned he is that strikes by taxi drivers and pharmacists could derail his reforms at home, he insists that when he wakes up in the morning, he is more concerned with “European leadership” than domestic unrest. “European leadership – not the German chancellor,” he quickly clarifies.”