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Analysis
Sending in the water cannon: ECB calls in the riot squad

Sending in the water cannon: ECB calls in the riot squad

by David Marsh

Mon 15 Aug 2011

LONDON — When legendary New Zealand mountaineer Sir Edmund Hillary was asked why he’d climbed Mount Everest, the highest peak in the world, in 1953, he gave a laconic Kiwi reply: ‘Because it was there.’ Similarly, a young English hooligan told a BBC reporter why he had looted shops during last week’s English riots: ‘Because no one stopped me.’

In both episodes, logical openings paved the way for certain actions. In the first case, heroic; in the second case, criminal. Opportunities presented themselves. They were taken.

Same in banking and finance. When trust, credibility and consent break down, anything can happen. If everyone queued up every day to get their money out of banks, finance would go bankrupt. If everyone wanted to smash windows all at once, no police force in the world could stop them.

When English police allowed the rioters to gain the upper hand in London and other cities a week ago, lawlessness spread with self-feeding force. Only when the police got over their feeling of defensiveness — New York–style zero tolerance, here we come — and escalated countermeasures, did criminal activity come under control.

Which brings us to the European Central Bank. In the week before last, a bubble and a vacuum were building up in the market for Spanish and Italian government bonds. In thin markets, selling reached pandemic levels. As a result of a hastily arranged telephone conference, the ECB council decided to apply its restarted bond purchases to the third- and fourth-largest economies of the euro area.

Similar to the police commanders sending in more personnel and telling them to wield their batons, the action calmed. Admittedly, on oversold markets. At least temporarily, the measures brought down bond yields to slightly more acceptable levels.

Even the vocabulary is similar. British Prime Minister David Cameron has been declaring he will ‘do everything necessary’ to stem unrest. That’s just what President Nicolas Sarkozy and Chancellor Angela Merkel have been saying about the euro.

Oddly, the outbursts have not affected the British government’s creditworthiness. The interest-rate differential between 10-year British and German government securities fell by the end of last week to just 0.2 percentage points.

But even the unlined features of Cameron creased slightly when he revealed that Britain was considering using water cannons to fight the tumult. For euro members, the equivalent would be agreeing to euro bonds — debt instruments under which Germany would effectively take over the debt of Greece. And possibly lose its AAA rating in the process. Which will come first? Water cannon or euro bond? The next few weeks may bring some answers.

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