Europe’s credit log-jam threatens to starve Greece

While the world wonders whether to gasp at Yanis Varoufakis’ taste in shirts, or the boldness of his financial planning, the negotiations taking place in the Athens Hilton with the International Monetary Fund, the European Commission, the European Central Bank and the European Financial Stability Facility, called the ‘quartet’ to distinguish it from the now-discredited ‘troika’, have revealed the insubstantial foundations that were created for the European Monetary Union in the 1990s.

The Maastricht Treaty inherited from the hubris of monetarism the dangerous notion that the only function for a central bank was to use monetary policy to keep inflation low. The private sector would look after itself, and all that governments needed do was balance their books. Above all, the central bank should not lend to governments, because to do so would be inflationary. This overlooked two centuries of central banking in which central banks acted as bankers to their governments and managed those governments’ debts for them. The function of managing government debt is especially vital at times of financial crisis when open market operations, the buying and selling of government paper by the central bank, is essential for regulating the liquidity of markets in long-term securities.

The result is that central banks in Europe and elsewhere were completely unprepared for either financial crisis, or the deflation that now hangs over Europe. The proposed Banking Union in Europe and the modest bond-buying efforts of the European Central Bank are not really adequate to the task. The reasons why are being exposed in Hilton hotel in Athens.

It illustrates clearly how out of touch are all those who think that it is just a matter of getting Greece out of the euroThe International Monetary Fund, the traditional foreign currency lender of last resort to member governments, is there. But it will not lend until it gets back the €1.55 billion that it was due at the end of June. The IMF has a policy of not lending to countries in arrears with their payments and so must clearly wait until the Greek government borrows from somewhere else to repay its arrears. The ECB is due to receive a €3.2 billion repayment on the 20 August and, though nominally independent, will have problems from its German government backers if it lends without receiving that money back. The European Commission does not lend money, and the Stability Facility will only lend with the agreement of its member governments.

The credit log-jam needs to be broken if the situation in Greece is to be stabilised. It illustrates clearly how out of touch are all those who think that it is just a matter of getting Greece out of the euro, or defaulting on its debt. The real problem is the absence of routine refinancing of government debt in Europe. In the absence of such facilities, the IMF would want the Europeans to refinance the €32 billion that the Greek government owes to the International Monetary Fund, since that would extract it from mess created by the European Monetary Union. The Germans would want the IMF to refinance the €56 billlion that the Greek government owes to the German government, since that would allow Wolfgang Schäuble and Angela Merkel to tell the German Parliament that they got their money back - similarly, and on a more modest scale, the French (€42 billion) Italians (€37 billion), Spaniards (€25 billion). The European Central Bank would want the €24.3 billion owed to it by the Greek Government refinanced by the IMF or other governments, so that it can tell European legalists that it is not lending money to any government.

The usual way in which governments borrow long-term, but lenders get their money back in the short term, is through liquid secondary markets in government debt. The biggest failure in the European Monetary Union is not that of the Greek government, but of the founding fathers of that Union who thought that consumer price stability was all that's needed to manage the economy.

Jan Toporowski is Professor of Economics at SOAS, University of London

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