Credit was crucial to the success of Western economies in the past 150 years. Without credit, there would have been no Industrial Revolution, no postwar recovery, and no information-technology era. Houses wouldn’t have been built, and shops wouldn’t have been stocked. All of them used borrowed money.
It is important to reflect on what credit actually is. The word means belief that debts will be repaid, or at least that certain crucial categories of debt, like the sovereign bonds issued by the governments of developed countries, will be. Take away belief and, literally as well as metaphorically, you have no credit. The difficult economic situation we now face derives from the breakdown of belief in the ability of some countries, notably Greece, to repay sovereign debts. But the ability to pay back isn’t something absolute and immutable.
Is there a will to repay Greek debt? That is a political judgment. But the arithmetic is also important. If the interest rate is too high, or the rate of growth in the economy and state revenue is too low, even the strongest political will to repay can be overcome. The more the markets demand a higher risk premium against the possibility that a debt won’t be repaid, the higher the interest rate will be, and the more likely market participants will be to guard themselves against nonpayment.
So, in a sense, the herd-like behavior of the markets, in demanding ever-higher risk premiums for holding Greek debt, is making more likely the very event whose consequences they are madly trying to avoid. This is the weakness of rating companies. They aren’t Olympian searchers for some objective truth. They are just mirrors, held up to the faces of panicky traders, reflecting back to them the terror in their own eyes.
Adult supervision of all of this has to come from outside the market, from institutions that aren’t driven by fear of losses, or appetite for gain. It also has to come from outside the political arena, where, in Europe’s case at least, the driving force is increasingly myopic nationalism, rather than an objective appreciation of a collective European interest.
This is why the role of the European Central Bank is crucial. It isn’t motivated by private gain or fear of private loss. Nor is it driven by politics. Its goal is to preserve a functioning credit system for the euro zone as a whole, and to print money in certain critical moments.
Wheels of Adjustment
Why haven’t there been attacks on U.K. bonds, even though Britain’s budget deficits have been worse than the euro-zone average? It is because the U.K. can print money and allow a little inflation into the system to oil the wheels of adjustment toward a more austere future.
Although the ECB has stretched its mandate to the full, it is still constrained in its ability to inject money into the system with the purchase of bonds. Its narrow duty to keep inflation below 2 percent — combined with political pressures from Germany and France, whose fears of inflation are out of proportion — has stopped the central bank from acting further.
The ultimate constraint on the ECB is political. There is an insufficient sense of a common European interest among the voters of the euro-zone countries. Populations were enthusiastic about Europe when it meant funds flowing from other EU countries, and secure, growing markets for the goods and services they wanted to sell. But now the flow of funds is reduced and has to be spread more thinly among more members, and the markets are still secure, but they are no longer growing.
Us and Them
There was no underlying emotional bond, no sense that the Greeks or the Germans are “us,” not “them.” The absence of an “us” feeling among the populations of the euro zone is now being laid bare. It is significant that when the governments of the EU countries came to redesign the constitution, which had been rejected in France and the Netherlands, they dropped the provisions on the European flag and anthem, which spoke to the creation of a common emotional tie between all EU citizens.
Symbolism is important and the constitutional downgrading of those symbols revealed an unhealthy contradiction between a desire to forge a common currency, and an unwillingness to demonstrate an allegiance to the entity that was embarking on that ambitious and hazardous enterprise.
Culture of Blame
We have seen where this has led. The use in recent times of the intergovernmental method, under which each member has a veto, to make key EU economic decisions has caused incoherence and delay, and has generated anger, frustration and a culture of blame. It only encourages grandstanding and contradictory nationalistic demands.
We need to revert to using the traditional EU decision- making method to make the new category of decisions required in the current crisis. This means a strengthened European Commission should develop proposals that are coherent and relevant to the interests of all countries, small as well as large. The Council of Ministers would need a majority vote representing at least 66 percent of the EU population, and the directly elected European Parliament would have to agree by simple majority.
The EU needs more than a financial solution to a financial problem. To restore credit, it needs to restore belief — not only in the EU as a project, but in the competence and quiet efficiency of European political institutions.