The euro area finance ministers meeting in Copenhagen have agreed on the size of the firewall, that is the funds to be made available to the new European Stability Mechanism and the way the funds in the existing European Financial Stability Facility are to be managed; see the eurogroup statement here.
They arrive at a headline figure of more than EUR800 bn, which, the ministers helpfully point out, is more than USD 1 trillion. And that’s important because … well, for no economic reason actually. There was a lot of pre-summit talk about the need for a one trillion euro firewall. The political compromise was 200 billion short, but convert into dollars and you get that magical number with twelve zeros.
Of course the one trillion mark has no real-world significance. It is all a matter of psychology. The simple fact is that the greater the sum – in euros, dollars or Vietnamese dong, it matters not – Member States are prepared to commit upfront, the more likely that speculating against a member country’s bonds will lose the speculator money. Consequently the smaller is the risk that such money will actually have to be lent to a country in crisis (with the risk that it might not be repaid).
The ‘no regret’ policy, then, is to have as big a fund as possible. OECD General Secretary Gurria called (it was inevitable that somebody would) for the ‘mother of all firewalls’. Will the announced measures be enough?
Well the headline figure does include more than one hundred billion euros that “have already been paid out to support current programme countries”. It is hard to see how it is justified to count money that has already been disbursed as part of a firewall to deter future speculation. EUR 700bn is a more realistic figure. But that is more than 7% of euro area GDP and approaches 50% of the GDP of Italy and 70% of Spain, the two countries of greatest concern. It is certainly serious money. It is welcome that the finance ministers have agreed to it, just as it was welcome that the ECB pumped some EUR 1 trillion – that magical number again – into the European banking system around the turn of the year. A bigger firewall would have been even better, but no-one can seriously set a precise tipping point at which the risk of speculative attacks is banished.
It is better to ask a different question.
Is this the best way to build a firewall?
The ECB, as the issuer of currency, can create a firewall at the click of a mouse of any size it chooses (albeit “only” in euros). If it had declared, as spreads were rising last year, that it would buy any government bonds whose interest rates, or spreads against German bonds, exceeded a given figure, rates would have been capped at that level. Fiscal sustainability would have looked much more feasible to bondholders and investors/speculators. Consequently the need for Member States to stump up money for a firewall would have been very much reduced: the daughter of all firewalls, so to speak.
Instead the central bank has lent money at extremely low interest rates to commercial banks, without any influence on what they do with it. Clearly the more resilient of them will lend it on at higher rates of interest. This is welcome for its impact on the real economy and sovereign debt markets, but it will certainly generate windfall profits for some financial institutions, much of which will then be paid out in bonuses to senior staff and dividends to shareholders. It is not clear to me that these are the elements of society most deserving of public support.
It is like watching climbers scale a particularly dangerous rock face. You can be happy to see them apparently making progress and still point out that they should have taken an easier (and signposted) route, that they risk showering rocks on innocent hikers below – and that they still may not reach the summit.