06 June 2012

Martin Wolf: Panic has become all too rational

The fear must now be that a wave of banking and sovereign failures might cause a similar meltdown inside the eurozone, the closest thing the world now has to the old gold standard, writes Wolf in his FT column.

In a panic, fear has its own power. To assuage it one needs a lender of last resort willing and able to act on an unlimited scale. It is unclear whether the eurozone has such a lender. The agreed funds that might support countries in difficulty are limited in a number of ways. The European Central Bank, though able to act on an unlimited scale in theory, might be unable to do so in practice, if the runs it had to deal with were large enough. What, people must wonder, is the limit on the credit that the Bundesbank would be willing (or allowed) to offer other central banks in a massive run? In a severe crisis, could even the ECB, let alone the governments, act effectively?

Furthermore, people know that both banks and sovereigns are under severe stress in important countries that seem to lack any prospect of an early return to growth and so suffer the costs of high and rising unemployment. No better indication of this can be imagined than Spain’s final cry for help with its banks. Political systems are under stress: in Greece, a fragile democracy has imploded. Meanwhile, the German government seems to have reiterated opposition to more support.

Before now, I had never really understood how the 1930s could happen. Now I do. All one needs are fragile economies, a rigid monetary regime, intense debate over what must be done, widespread belief that suffering is good, myopic politicians, an inability to co-operate and failure to stay ahead of events. Perhaps the panic will vanish. But investors who are buying bonds at current rates are indicating a deep aversion to the downside risks. Policy makers must eliminate this panic, not stoke it.

In the eurozone, they are failing to do so. If those with good credit refuse to support those under pressure, when the latter cannot save themselves, the system will surely perish. Nobody knows what damage this would do to the world economy. But who wants to find out?

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