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Hard money central banks prepare ‘crisis management’

Hard money central banks prepare ‘crisis management’

Countdown to potential Greek exit

by David Marsh

Mon 28 May 2012

The Swiss National Bank’s weekend warning that it is considering imposing capital controls on foreign deposits if Greece leaves the euro is a portent of battles and turbulence ahead. As the countdown gets under way to a potential Greek exit from economic and monetary union (EMU), the hard money central banks of Europe are preparing what they call ‘crisis management’ to handle coming squalls.

Thomas Jordan, president of the Swiss National Bank, said the Swiss government and the SNB were looking at ways of dealing with an expected flood of foreign money into the country in the event of a Greek exit. This backs up repeated statements by the Bundesbank that it is preparing for such an eventuality. The strongest statement came from the German central bank in an unusually blunt article in its monthly report for May, released last week:

‘Current developments in Greece are extremely worrying. Greece is threatening not to implement the reform and consolidation measures that were agreed in return for the large-scale aid programmes. This jeopardises the continued provision of assistance. Greece would have to bear the consequences of such a scenario. The challenges this would create for the euro area and Germany would be considerable, but manageable given prudent crisis management.’

In a statement that was reinforced in a subsequent interview with Le Monde, the French daily paper, the Bundesbank continued:

‘By contrast, a significant dilution of existing agreements would damage confidence in all euro-area agreements and treaties and strongly weaken incentives for national reform and consolidation measures. In such circumstances the institutional status quo comprising liability, control and individual responsibility of member states would be fundamentally called into question. When the Eurosystem provided Greece with large amounts of liquidity, it trusted that the programmes would be implemented and thereby ultimately assumed considerable risks. In the light of the current situation, it should not significantly increase these risks. Instead, the parliaments and governments of the member states should decide on the manner in which any further financial assistance is provided and therefore whether the associated risks should be assumed.’

The evident preparations by the Bundesbank and the Swiss National Bank stand in contrast to the palpable indecisiveness of euro area governments. The position has not been helped by unsolicited advice from the British government. The latest example came at the European Union heads of government meeting last Wednesday when UK prime minister David Cameron once again called upon the European Central Bank to ‘get behind’ the single currency through ‘monetary activism’ that presumably includes further cuts in interest rates and purchases of weaker country bonds.

He received a deserved reprimand from Mario Draghi, the ECB president, who told him (in polite terms) to mind his own business. Draghi’s intervention, dressed up as an admonition for the UK leader to desist from any kind of pressure on the central bank’s cherished independence, was justified, for three reasons.

First, as pressure builds on Greece, it is clear that Germany and the other creditor nations are not going to budge from their implacable desire to keep up the squeeze on Greece and other large-scale debtors. Second, the ECB itself has repeatedly made clear in recent months that Europe-wide quantitative easing of the sort undertaken by the Federal Reserve and the Bank of England is well-nigh impossible. Third, by taking sides in the EMU argument between debtors and creditors, Cameron is generating bad blood on both sides – and risks putting himself and his country at a disadvantage when it comes to repairing the damage after the storm has broken. In the inevitable recriminations that will follow a coming EMU dislocation, Britain could theoretically be in demand as an “honest broker” to help heal wounds and produce compromises between competing factions – similar to the role previous governments played in successive European monetary crises in the 1980s and 1990s. By annoying other leaders with his crass comments, Cameron seems very unlikely to be able to play this constructive role.

One clear signal of rising tension is the roughly €100bn of emergency liquidity provided by the Bank of Greece to prop up the country’s banks. If Greece on 17 June votes in a government that suspends payments on its debt (no doubt terming this a “temporary” measure) but nonetheless says it wishes to remain in EMU, the ECB would be thrust into a position of dire responsibility. As Weidmann has pointed out in recent days, the ECB council can veto this ‘emergency liquidity assistance’ (ELA) through a two-thirds majority of the governing council (currently 23 people, but due to fall to 22 at the end of May).

Rallying the two-thirds majority (which would presumably include French members of the ECB council) would not be an easy task, and, given the historic nature of the decision, the ECB would wish to share responsibility for EU governments if Greece was pushed into a position of leaving (or drastically modifying its position within) the euro area. If the ELA is stopped, Greece no longer has a choice apart from leaving, since its banking system would crash more or less immediately. However, unless Weidmann was reasonably sure of accomplishing the two-thirds majority, he no doubt would not have made public that he needed it.

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