Author : John E. Charalambakis
Date : November 24, 2011
In March 1914, the Federal Reserve Bank (Fed) started its operations in the US. Within fifteen years the depression was taking root in the US. Seventy years later, the European Central Bank (ECB) was starting its operations and in a twist of fate, in about ten years from that glorious start, the fears of depression and financial chaos have started spreading throughout the EU.
The ECB is like a huge cruise ship without an anchor. With all due respect I do not want to be on that ship. It started on a voyage in the high seas and not only was it lacking an anchor but it also lacked a compass. At the same time, whenever the captain was warned of the dangers, he kept ordering the orchestra to play louder so that dissenting voices could be silenced. The result has been an over-extension of credit, the collateralization of overvalued assets, and the securitization of toxic bonds. All the while it perpetrated the idea that what are actually third-party liabilities (i.e. bonds) should be counted as assets.
During all this time, the ECB targeted the wrong objective and used inappropriate tools to achieve that misguided objective. Dogma in central banking is like oxygen in life. While we cannot see it, we cannot live without it. The fundamental dogma of any central bank is reflected in its ultimate role to ensure financial stability. The ultimate weapon/tool in this endeavor should be its ability to be the lender of last resort in turbulent times like nowadays, or to be the entity that turns off the credit faucet when there are too many leaks (such as over-extension of credit) in the system. The ECB failed in the latter during the 2000-2008 period and thus all the bubbles and over-blown government deficits that have now surfaced.
Unfortunately, it seems that the ECB is failing miserably again, by refusing to be a lender of last resort (see our commentary dated November 3rd). The design of the Euro resembled schizophrenia in three fronts: First, it lacked a unified Treasury department that would be responsible to issue Euro-wide bonds. Second, it designed a central bank and removed from her the ability to be what she is supposed to be, creating in the process a monster that suffers from an identity crisis. Thirdly, it lacked vision to unify the peoples of Europe who had then and still have divergent cultures, priorities, histories, values, and traditions. The result of these three basic mistakes has been an exostosis that turns out to be malignant cancer.
The easiness of credit encouraged profligacy among banks, governments, corporations, and individuals. The Euro became the blood of an organism that was infected with a deadly virus. That organism freely moved among the passengers of the vessel as it was cruising in the seas. Contagion was the natural effect and now is affecting all Euro zone economies.
So, what should we expect? If the vessel had an anchor, it could probably sail into a port. The problem is that it neither has the needed anchor to stabilize the ship nor the compass to find the port. Helicopters are needed who can parachute special surgeons and a captain (aisimnitis, see related commentary dated December 10, 2010). The former will perform surgeries on the cancer (the toxic bonds of over $4 trillion dollars worth in the EU banking system), and the latter (aisimnitis) will set direction to the vessel with the compass he will bring onto the vessel. The outcome will still be uncertain given the absence of an anchor. If those steps are not taken, my fear is that contagion will make catastrophe a certainty in a few years time, and the history books will devote a section of lamentation to what was a grand dream built on feet of clay.