THE RETURN OF THE LENDERS OF LAST RESORT, by François Leclerc

Guest post. Translated from the French by Tim Gupwell

Here is a summary of the situation. Newly named Prime Minister, Antonis Samaras is continuing to put together a government which was voted in on the basis that it would renegotiate a bail-out plan which is falling apart anyway. In supporting him without sending in any of their big names, Pasok and Dima are doing the strict minimum, which augurs badly for the outcome of the experience. In Brussels the new Greek finance minister is awaited resolutely, with, at best, extensions to the time frame likely to be granted. “Renegotiating the Greek bailout would be a very dangerous strategy. It would harm those countries that are quietly implementing reforms”, warned Jens Weidmann of the Bundesbank.

In Cyprus, the government is attempting to save the banks, which have been heavily affected by the Greek debt restructuring, negotiating a new loan from Russia and asking for a bail-out along the lines of the Spanish model, which is creating a precedent before it has even been finalized – in other words, a bail-out reserved only for the banks, and without any other conditions being attached (other than for the banks themselves).
Spanish officials are still refusing right up to the very last moment to ask for any kind of bail-out plan, in the hope of avoiding any further budgetary cuts being imposed upon them in return, at a time when trade union demonstrations have invaded the streets of the country’s cities, and the government has forgone all its credibility by prioritizing a rescue of the banks. The suspense should be partially lifted today at the meeting of the Euro group (which will bring together the Eurozone’s Finance Ministers), once the results of the first audit of Spanish banks are made known. But there will be a lot more to come, because an amount of 400 to 500 billion Euros will be needed if Spain is going to be able to get by without the capital markets over the coming three years…

The crisis has spread to Italy, where Mario Monti is now being challenged, having being on the receiving end of a fresh snub from Angela Merkel. She refused to allow the EFSF to directly purchase sovereign debt to ease the rates. This was in spite of the fact that this measure has already been adopted over a year ago; Benoît Coeuré, an ECB executive board member, said that it was a mystery why this possibility has not yet been exploited.

The mystery in question is likely to be resolved soon, quite probably in the heat of action. Is it to be expected that the ECB will intervene as the lender of last resort? It has held fire since February in order to force the governments to assume their responsibilities. Nor is it convinced that any new measures they take will have a significant impact, as Benoit Coeuré recognized. Prudently evoking the prospect of a reduction in the ECB’s main interest rate which still stands at 1%, he considers that “as regards the current crisis, it is certainly an option, but like all we do at the current juncture, it would certainly not fix all the fundamental problems”.

As for the Bank of England and the Fed, they are heading towards a large scale renewal of their operations of monetary creation and injections of liquidity, as indicated by the minutes of the meeting on the 6th and 7th June for the former, and the press release yesterday (Wednesday) from the Federal Open Market Committee. For the time being, the Bank of England has launched a monthly programme of 5 billion Pounds of loans to the banks, and the latter has decided to further pursue its “operation twist” which consists of exchanging the 267 billion Dollars of American debt securities with the short maturities (less than three years) which it holds, against longer term securities with terms of between six and thirty years. A good means of withdrawing this long-term debt from the capital markets.

The creation of new debts in order to finance an existing debt that it is proving impossible to bring down, and the financing of these new debts by the creation of new money, seems to be the only path still available. We can call this ducking the issue or expediency, and remind ourselves that it has already been tried without success. The stimulation of growth which could facilitate a reduction in the debt remains wishful thinking. The debt manufacturing machine which is at the source of it cannot be started up again, as its motor is still broken.