Merk Commentary: ECB – Greece No California

At its monthly press conference, European Central Bank (ECB)President Trichet was assertive in calling for fiscal discipline in its16 member states that comprise 330 million people using the euro.

At its monthly press conference, European Central Bank (ECB)President Trichet was assertive in calling for fiscal discipline in its16 member states that comprise 330 million people using the euro. Askedabout bailing out Greece or other member states with severe fiscalchallenges, Trichet called the ECB collateral framework crystal clear, applying erga omnes(equally) to every member state; no special treatment will be providedto any one member. In the euro zone, member states may receive fundingfrom the ECB by posting collateral, but only if their debt isappropriately rated by the major credit rating agencies.

Comparingthe euro zone to the United States in size and diversity, Trichet saidthat there are always more competitive and less competitive regions.Being part of the euro provides benefits, such as easy funding ofcurrent account deficits, as well as a credible currency. Beyond that,it is the responsibility of member countries to do their job to conductstructural reform. It is in the interest of member countries to helpthemselves.

Asked about any threat to the eurobecause of Greece’s problems, Trichet pointed out that Greece’s GrossDomestic Product (GDP) is a mere 2.5% – 3% of the euro zone GDP. InCalifornia, which has its own set of severe fiscal challenges, themagnitude of the problem is far larger (California’s GDP is over 12% ofU.S. GDP). He went on to stress that euro zone budget deficitscurrently amount to about 6.5% – 7% in the aggregate, compared to 12%in the U.S.

Asked about the strong euro, hereiterated the importance that the U.S. be committed to a strong dollarand a monetary policy inspiring confidence. Given the statisticshighlighted by Trichet, it is fair to assume that he would like to seemore fiscal and monetary restraint in the U.S. While it would not beappropriate for Trichet to directly comment on fiscal or monetarypolicy in the U.S., he was more assertive than ever in calling forfiscal discipline within the euro zone. He reminded member countriesthat achieving deficit targets is not merely a goal or request, but a requirement.He cautioned that tax cuts should be considered only in the medium termonce an exit strategy for fiscal emergency spending programs is inplace.

While giving very little guidance on interestrates and upcoming monetary policy, a noteworthy comment of his wasthat an increase in indirect taxation in countries’ efforts to achievefiscal consolidation may pose a threat to economic growth.

Trichetsaid that the ECB, along with other central banks and governments havetaken bold decisions to avoid a depression; the situation had beenvery, very grave and there are still a lot of problems. Commenting onfinancial reform, Trichet said the Asian crisis showed it is veryimportant that banking supervision should be independent of government.

While many are concerned about the rising spreads insovereign debt in countries such as Greece, we welcome the increasedscrutiny the market gives. If anything, spreads that had been toonarrow for too long have allowed euro member countries to postponestructural reform. The market is finally correcting this key flaw inthe design of the euro. California in the U.S., too, shares a singlecurrency with millions of others; but California is rightfully paying ahigher price to finance its spending than other, more fiscallyresponsible states. In the euro zone, fiscally responsible countriesare finally rewarded through a lower cost of financing their debt thantheir less prudent peers. There is a limit to how much the ECB canpolice fiscal spending; but the ECB can allow the market to punishthose who are fiscally less responsible. Only then are the incentivesprovided for structural reform and fiscal restraint.