Saturday, March 12, 2011

Chronicle Of A Policy Error Foretold

One thing anyone with a high public profile and responsibility for delivering policy needs to remember is that if you don’t want to unwittingly stick your foot in it, the best policy surely is to keep you mouth tightly shut. Really someone should have reminded ECB President Jean-Claude Trichet of this basic rule-of-thumb technique for staying out of trouble before the last monthly meeting of the ECB. Wisdom tells you it is better to say nothing rather than risk stirring up a hornets nest.

Unfortunately M Trichet must have had something of a bad day. "The position of the Governing Council is that an increase in interest rates at the next meeting is possible," he told the astonished journalists who had assembled for the post-monthly-meeting press conference with his usual dead pan style.

Now the problem with this latest policy initiative is not only that it represents something akin to the chronicle of an early death foretold for a much troubled and highly fragile Spanish economy, where around 90% of mortgages are variable rate ones. It also draws attention to an area which it would be much better for the ECB not to draw attention to at this delicate moment in its history: the convenience of having a single size monetary policy applied to such a diverse group of economies.

Somehow or another this particular issue had managed to drop under the radar since the start of the current crisis, but now this inept step from the ECB risks putting the problem once more right at the heart of the Eurozone debate. Only last week former Irish Premier John Bruton directly and openly accused the ECB of having fuelled the Irish housing bubble. Now the ECB itself risks generating a bout of ire in Spain, where many will ask what was happening to all this strong vigilance at the time when their construction boom was getting fired up.

So now, not only do the extremely weak peripheral economies have to handle their problems without the luxury of having a currency to devalue to restore lost competitiveness, and without the support of a central bank which willingly buys their government bonds in order to bring down the interest rates being paid on them to reasonable levels, they are also about to have a monetary policy applied which is thoroughly inappropriate to their needs.

Inflation on the periphery has much more to do with rising commodity prices and the application of a misguided policy of consumption tax increases as a way of reducing fiscal deficits than ever it has to do with economic overheating. In fact the situation in these economies is quite the opposite, with domestic demand being congenitally weak, and an overvalued currency (for their needs) giving them competitiveness issues when it comes to boosting exports. So applying a monetary policy which may even lead to some appreciation in the currency hardly seems to be the best thought out proposal in the world.

Unfortunately it has been a bad week for the euro generally. To the obvious problem that seeing the incumbent Irish government thrashed in elections will hardly motivate others to follow down the same austerity driven path, was added the fact that Moody’s swept in with a swinging downgrade on Greece, while Portugal’s bond yields continued to hit ever new highs. In the Greek case markets are already factoring-in the likelihood of a debt restructuring starting as early as this autumn. But then, as if to cap it all, the continuing ability of President Gadafi to maintain his vicious grip on his country’s population is continuing to pile pressure on the Italian sovereign spread. The problem with all of this is that it creates the impression of an ongoing drift towards chaos, a chaos which will evidently only grow in the absence of anyone at the centre able to get a grip on the situation, and channel all that negative energy off into a much more positive direction.