No End to Europe’s Reign of Error

10/06/2011 10:40 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

The ECB’s failure to cut rates ahead of a recession means the debt crisis will only get worse, writes senior editor Igor Greenwald.

Jean-Claude Trichet, the outgoing president of the European Central Bank, is an extremely principled public servant.

Sure, he said he wouldn’t even consider purchases of sovereign bonds in May 2010, only to capitulate days later under enormous pressure from the markets and politicians.

And sure, he insisted on certain standards for collateral the ECB would accept in exchange for its liquidity injections, only to relax these rules time and again as required by the borrowers’ deteriorating finances.

But Trichet draws the line at lowering interest rates to respond to imminent recessions. It’s why he hiked rates in the summer of 2008 when the entire world knew Europe would soon be contracting. It’s why he raised borrowing costs twice this year despite a severe credit crunch choking off growth.

As a Frenchman, Trichet feels a special responsibility perhaps to fear inflation even more than any German. As a result, he will leave office this month with the Grand Cross First Class of the Order of Merit from Germany, and similar baubles from France, Netherlands, Austria, Belgium, Ivory Coast, and Ecuador.

What he can’t take with him into retirement is what other central bankers value most: knowledge that the economy is healthier for their efforts on its behalf. If he does think so, he will be fooling no one but himself.

Eurozone inflation is running at 3%, and that’s actually as good as the news gets over there. Growth, consumer demand, and industrial production all across the continent are in retreat, and most outsiders believe another recession is already under way.

The European periphery has been brought low by austerity, while the prosperous export-driven core is starting to feel the effects of the slowdown in Asia and the Americas as well. European banks are facing a severe funding crisis, effectively turning into wards of the ECB and the Federal Reserve, which is lending dollars the market is no longer willing to supply at affordable prices.

Trichet had one last chance to acknowledge these realities with a rate cut today, and he declined, of course. Perhaps having surrendered so many of his principles of late, he felt compelled to draw the line somewhere.

History will not be kind to a man who thought he was teaching monetary prudence to the Fed, only to eventually come crawling hat in hand on behalf of the suspect banks in his care.

The good news is that some of Trichet’s countrymen are starting to speak out as well. “Farewell, you certainly won’t be missed,” was how leading French investment manager Edouard Carmignac began his $150,000 poison-pen letter to Trichet. That’s roughly what it cost to publish it as a full-page ad in yesterday’s Financial Times.

“During your career you will have dealt a fatal blow to the French industry with your strong franc policy in the 90s, deepened the impact of the 2008 crisis by underestimating its scale and, more recently, endangered the euro with ill-considered rate hikes and clearly inadequate support for the debt of weakened European countries,” Carmignac continued.

He suggested Trichet drop his key interest rate from 1.5% all the way to zero, and announce plans for unlimited purchases of the distressed European countries’ debt. Had Trichet done so, we would be looking at a massive rally across global markets this morning, celebrating the end of the European debt crisis. Obviously, fat chance.

That’s not all Trichet’s fault, of course. Even the half-measures he’s taken to date have caused dissent within the ECB and resignations of two German representatives.

Unlike the Fed, the ECB is not charged with maintaining employment as well as price stability—its mandate is to keep inflation at bay, jobs be damned. His calls for a bigger fiscal response to the crisis have been frustrated by similarly gradualist and parochial national leaders.

Still, Trichet had the chance to transcend precedents and narrow institutional interests, to lead a continent hopelessly hobbled by national divisions. He failed.

He will be replaced next month by Mario Draghi, an Italian who will have even less room to maneuver given Italy’s struggles and German biases. Expect the European mess to get much messier.

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