Eurozone Crisis: Why the Fed Should Buy Italian Bonds
The economic news out of the eurozone is getting worse every day, and so is the contagion to the rest of the world. The OECD (Organisation for Economic Cooperation and Development), the club of 34 mostly high-income countries, has now lowered its projection for eurozone growth for 2012 from 2% (in May) to just 0.2%. According to their report, the 17-member eurozone economy already "appears to be in a mild recession". For the US, the forecast for next year was lowered from 3% to 2.1%.
Forecasts for China, India and Brazil have also been lowered significantly since May. From Asia to Latin America, the problems of the eurozone are reverberating as international banks contract credit, big investment projects are cancelled or postponed, stock markets and real estate prices fall, and investor and consumer confidence drops. And these poor OECD projections assume that Europe "muddles through" its current financial crisis without any significant financial disaster. But as the eurozone economy worsens, this assumption gets increasingly less tenable.
The simplest solution to the crisis is for the European Central Bank(ECB) to buy enough of the Italian and Spanish debt – and, possibly, other eurozone countries' debt – to push down interest rates to a safe level. On Tuesday, Italy paid a record 7.89% yield for three-year bonds that it auctioned, well above the 7% level that was seen as a threshold for Greece, Ireland and Portugal to move from market financing to the International Monetary Fund (IMF) and European authorities. With lower borrowing costs, Italy and Spain would not be facing a "debt crisis".
In fact, this whole crisis and recession could have been prevented very easily if the European authorities had simply intervened to maintain low interest rates on the Greek debt a year and a half ago. It is possible that some restructuring might still have been necessary, but the cost would still have been very small relative to the available resources of the European authorities. Because they refused to do this, and, instead, shrunk the Greek economy, increased its debt burden and allowed its borrowing costs to skyrocket, the crisis spread to other, weaker countries of the eurozone, including Italy. And now capital – including American money market funds – is fleeing Europe's banking system, threatening a systemic financial crisis of unknowable proportions.
This failure to act – then and now – shows clearly that this is not a "debt crisis" at all, but rather a crisis of failed policies. Eurozone finance ministers met Tuesday, but failed again to come up with any credible solution that would stabilise the situation.
ECB intervention to stabilize eurozone bond markets is the most obvious, and possibly the only practical solution, for several reasons. First, it is the only institution that can move quickly to bring the situation under control at a moment in which we really don't know how far we are from a meltdown. Nobody anticipated that Germany, for example, would have trouble selling its bonds last week – there will be other unanticipated events that could possibly set off a panic at any time. Second, the ECB can buy the sovereign bonds of Italy or Spain at no cost to the European taxpayer. This is a serious issue, since the amounts of money involved could be large enough to present a political problem in Germany and other better-off eurozone countries.
Just as the US Federal Reserve has created $2.3tn since 2008 and used it to buy securities in the United States, the ECB could do the same in Europe where such buying is much more desperately needed. And just as there was no measurable effect on inflation in the United States, we would not expect any problem with inflation in Europe. Inflation in the eurozone is currently projected to fall to just 1.6% for next year.
The problem is that the ECB, and other European authorities led by the German government, are still playing the same game of brinkmanship that they have been playing for the past two years. They are more concerned to press austerity policies on the weaker eurozone countries than they are about tanking the European and global economy. They continue to see the crisis as an opportunity to force through unpopular "reforms" – such as cutting jobs and pensions, raising the retirement age, privatisations and reducing the size and scope of the welfare state.
They have already caused a recession in the eurozone and seem more than willing to let it deepen in order to get what they want. The big question now is whether their recklessness will bring on a new financial crisis that triggers a world recession.
Some of us have called for the Federal Reserve to intervene before this happens and do the ECB's job for it. The Fed has the capacity to do so, and like its prior quantitative easing in the US, this would be costless to the taxpayers. It might cause a bit of a political storm, but that would be a small price to pay to avoid another recession that would throw millions more people out of work – in the United States, Europe and much of the world.