Like a good horror movie, accepting the possibility for the Euro disaster to be averted at this point requires a healthy suspension of disbelief. In fact, so much disbelief must be suspended that it would make the Exorcist seem like a documentary.
The fix, of course, is for the European Central Bank to print money and monetize the debt.
You can only believe in this ending to the story if you ignore the issue that it may be illegal. The treaties governing the creation and operation of the ECB say it is not supposed to buy sovereign bonds or do anything not in furtherance of its mandate, which is price stability. (For an excellent discussion of the details of all this, check out this blogby Douglas Huggins.)
Then you have to ignore just about everything every German official has said in opposition to monetization. From Chancellor Merkel to Wolfgang Schauble at the Finance Ministry to Jens Weidmann at the Bundesbank, Germans have been united that the ECB shall not be used to monetize the countries' sovereign debts.
Oh, and then there’s the slight problem that Mario Draghi, the new president of the ECB, also doesn’t think the ECB can do this.
“I do not think that this is really within the remit of the ECB. The remit of the ECB is maintaining price stability over the medium term,” Draghi said at his first press conference.
And yet, the movie cannot possibly end there. Can it? There is a long-shot line of thinking that suggests, despite all these considerable and seemingly insurmountable objections, that monetizing the debt is exactly what the ECB will do.
The reason is simple: it’s because it’s what they have to do, because there is no other way out of this mess. The notion of leveraging the European Financial Stability Fund has failed; there will be no additional money from the International Monetary Fund without US approval, which won’t come without Europe putting up substantial funds of its own, which won’t come without approval of all 17 nations, which won’t come.
It looks increasingly like there are two choices: letting the Euro zone fall apart, or ECB standing behind the sovereign debts . The calculus among a very few analysts is that they will step in and the Germans will reverse themselves when they face the abyss.
One of the main German concerns, for example, is about the possible inflation that could result from rolling the printing presses. Fears of the Weimar Republic animate much of German economic thinking.
But how much would the Germans really care about inflation in a Euro zone that no longer existed? And if the choice were between inflation and devastation to its export economy from a much-appreciated currency, Germany might finally back monetization. Would the ECB really not take the one action that it could to preserve the euro zone, which is its job is to protect?
Finally, the legal hurdles could be finessed by defining the problem in terms of the mandate. It doesn’t seem like such a stretch to argue that the default of a sovereign government with its disastrous follow-on effects on the European banking system would be a major deflationary event. That is to say, in the preservation of price stability the ECB must monetize.
Like I said, it’s a horror movie and you have to suspend disbelief. But it could happen.