Plan A is a sham

Since my previous entry (Final Fantasy), it has become something of an orthodoxy that the problem is not confined to just the periphery Eurozone, and in fact all countries (US included) must now start making real efforts to balance their books.

But the problems with the official line go deeper than this. Our current plan, is for the Eurozone countries to collectively borrow money and lend it to the weakest countries (Greece, ireland and Portugal), while structural and fiscal reforms take place. A classic international bailout -Plan A. This was always going to be a difficult plan that needed commitment in word and deed from both the net borrowers and the net lenders. However, it has received little from either. Now, with the downgrade of Italy's credit rating, it is no longer a viable plan.

The great kerfuffle last week at Germany's approval of the 2nd Greek bailout package misses the point completely. That Germany has agreed, at the 11th hour, to supporting Greece is no longer a useful decision. While the Germans (and others too it must be said) dithered and protested at Plan A, Italy's credit rating was downgraded, and now she is rapidly losing access to the markets. It now seems unlikely (although this reality has yet to hit home) that the Italians are going to be able to fund their portion of the 2nd Greek bailout. As a large country, their contribution is indispensible to the success of Plan A. But realistically, the idea that Italy is going to borrow money at 8%+ and then lend it to Greece at 3% while trying to reign in their own deficit is a fairy tale.

It now seems that Plan A is unworkable, it just hasn't sunken in yet. Plan B is going to be more chaotic. It could take the form of countries exiting the currency union (harmful to banks, diplomacy), a global bailout of indebted eurozone countries (unlikely), common borrowing (politically unpopular and diplomatically undesirable) or more robust action from the European institutions to support the currency.

Personally, I think Quantitative Easing is the way to go. This has been anathema to the Eurozone until now because of cultural issues about inflation -but inflation is the very thing we need. Inflation punishes money hoarders, relieves the indebted, forces the wealthy to invest/spend. It is the principle tool FDR used to lift America out of Depression and it is IMO the best solution to our current problems. If the Euro-area inflation rate was artificially boosted to around 4-5%, we would quickly see convergence between the core and the periphery. We would also see a lift in economic activity as money hoarders would be forced to spend or invest. Finally, it would deleverage the economy, relieving the indebted, the banks and even the sovereigns. Quantitative easing has the added advantage of also providing a large amount of cash as ready ammunition for the central bank to use to fight financial fires for a few years.

It will be 3 years next week since I advocated the use of inflation to fight the financial crisis. The UK and the US have followed my advice and recovered from what were far worse starting positions than Europe. However, paralysed by cultural sensitivities, Europe has refused to take its medicine. But now, the alternatives have become so terrible that I feel sure our next step (Plan B) will be Quantitative easing and inflation. Once we get on with it, we will start to wonder why we made such a fuss about it in the first place and caused so much hardship to Europeans. Stupidity, I believe.