And now, Germany.
Earlier this week, we started to see the clearest possible sign that the European sovereign debt crisis was no longer about shady budgeting in Greece or slow growth in Italy because problems started to afflict Finland, Austria, and the Netherlands. Nobody really cares about those countries, but they’re key. Austria is very similar to Germany and slightly less indebted. Finland has a very low debt-to-GDP ratio. The Dutch are the economic stars of Europe, with amazing labor market flexibility and incredible productivity per hour worked. These are small countries, so they don’t “matter” that much but as canaries in the coalmines go, they’re more German than Germany. Risk to their borrowing capacity reflects fundamental fears about the continued existence of the Eurozone and those fears are driven by fundamental mismanagement of the enterprise. Today comes the news that, yes, even Germany is in trouble as “a ‘disastrous’ sale of German benchmark bonds sparked fears on Wednesday the debt crisis was beginning to threaten even Berlin, with the Bundesbank forced to dig deep into its pockets to ensure the auction did not fail.”
This takes us back to the fundamental structural issue that’s been exposed here. Sometimes central banks need to dig into their pockets in order to keep bond interest rates low. But when rich countries’ central banks dig, what they find is their pockets are full of printing presses. The Federal Reserve can’t run out of dollars. The Bank of England can’t run out of pounds. The Bank of Japan can’t run out of yen. The Svergis Riksbank can’t run out of kroner.
Third world central banks aren’t like that. To be sure, their central banks can print whatever they want. But generally speaking international capital markets don’t want to lend in dodgy third world currencies. These governments need to borrow dollars, and their central banks can’t print dollars. That puts them in a fundamentally different risk category from Canada or Sweden or the United States. And here’s the rub. The Bank of Italy, like the Bundesbank, turn out to more closely resemble a third world central bank than a first world one. They can reach into their pockets and pull out some euros, but they can’t print euros. The only one who can print euros is the European Central Bank. And though the ECB has in fact been willing to intervene sporadically on secondary markets, it hasn’t made any clear policy commitments and many key players keep insisting that it neither can nor should serve as national central bank to its lender states.
This has gotten tied up with the toxic politics of bailouts and German popular disdain for countries that run current account deficits. But we’re seeing here is that these design flaws have systematic consequences. Sure they hit Italy before France and France before Germany, but once the Eurozone’s leaders failed to ringfence the problems around Greece and Portugal the problem metastasizes very quickly.