As he prepares to stand down from the European Central Bank later this year, Jean-Claude Trichet could be forgiven for asking himself why he bothers. Having steered the euro zone through crisis after crisis, the criticism of his time running Europe’s central bank gets louder and louder.
Der Spiegel reported Monday that the ECB has skeleton risks on its balance sheet amounting to several hundred billion euros following years of accepting government debt from the likes of Greece and Ireland onto its balance sheet.
Without the support of the ECB the impact of the financial crisis on the euro zone and its banking system would have been far worse but the central bank's complete rejection of the idea of restructuring of Greek debt is now being viewed as the problem, not the solution.
Paul Krugman, the Nobel Prize winning economist has unleashed a scathing analysis of ECB policy and its reliance on the "confidence fairies" in Monday's New York Times.
“In Europe the pain caucus has been in control for more than a year, insisting that sound money and balanced budgets are the answer to all problems,” Krugman wrote.
“Underlying this insistence have been economic fantasies, in particular belief in the confidence fairy - that is, belief that slashing spending will actually create jobs, because fiscal austerity will improve private-sector confidence,” he continued.
“Unfortunately, the confidence fairy keeps refusing to make an appearance. And a dispute over how to handle inconvenient reality threatens to make Europe the flashpoint of a new financial crisis,” Krugman concluded.
Krugman is not alone in fearing ECB policy will lead to bigger problems down the road.
“We fear that the ECB’s position on restructuring and its penchant for raising interest rates will worsen the eventual crisis rather than help to resolve it,” said Carl Weinberg, the chief economist at High Frequency Economics in a research note.
In Weinberg’s view the ECB is cutting off the route to orderly restructuring of Greek debt and pushing the markets towards disorder and higher yields.
“An uncontrolled default will bankrupt all the banks in Greece and an unknown number of other financial institutions around the euro zone,” he wrote. “Think of a Greek default as an event similar in scope and effect to Lehman’s failure.”
This is actually what Trichet and his colleagues on the ECB governing council are worried about. In April Spain’s ECB representative José Manuel González-Páramo warned that a Greek default would lead to a crisis to match Lehman Brothers, while his colleagues have been talking up the current plan claiming Greece’s problems are a failure to stick to debt reductions plans.
Only time will tell who is right but with the downgrades to outlook and ratings of the euro zone’s weakest members coming thick and fast while the euro falls that day could be closer than we thought just a few days ago.