Sarkonomics would drag EU up a creek

Two big German banks have had to be rescued from collapse this summer. The giant Bank of America has had to supply $2 billion (€1.46bn) of new share capital to support Countrywide Financial, America’s biggest private sector home mortgage lender, amidst fears about its capacity to continue to do business. Goldman Sachs, no less, has had to use $2bn of its own money to bail out investors in its computer-managed Global Equity Opportunities hedge fund, and BNP Paribas had to freeze customer access to three of its investment funds. Even two Chinese banks had to admit to heavy losses in the ‘junk’ segment of America’s mortgage-backed securities market.

Underlining the severity of the summer’s global banking crisis, on 9 August, just two days after the Paribas decision, the European Central Bank (ECB) had to pump an exceptional €95bn into eurozone money markets in order to prevent Europe’s banking system seizing up. Like its US counterpart, the Federal Reserve, the ECB then had to keep massaging the money markets throughout the month to try to stabilise them and the world financial system.

The threat of a global financial crisis did not, however, prevent the impetuous Nicolas Sarkozy, the French president, from re-launching his thinly veiled attacks on the ECB, but at a singularly inappropriate time, so conjuring up memories of the reckless German finance minister ‘Red’ Oskar Lafontaine. It was Lafontaine who, backed by then French finance minister Dominique Strauss-Kahn, decided in 1999 that the launch of Europe’s new central bank was the right moment to start trying to undermine its independence.

The photographically improved Sarkozy last week (23 August ) praised the US Fed for cutting its discount rate on 17 August, saying that Europe, too, should not "deprive itself of the weapon of interest rates", in the midst of such turmoil. He blithely ignored the fact that the crisis has been generated in the United States and stems directly from the irresponsible monetary policy actions of former Fed chairman Alan Greenspan. Faced with the dotcom stock market crash in 2001 Greenspan slashed US money market rates to 1%, triggering a buying and borrowing frenzy in the US housing market which sucked in speculators from around the world.

This bubble is now unwinding and could hit the American economy hard. The ECB, however, did not panic in 2001, but cautiously, in the face of stubborn inflation, lowered its policy interest rate to 2% in 2003. It then began to increase the policy rate in December 2005, judging, correctly, that eurozone growth was recovering.

Most private economists are not yet expecting eurozone growth to collapse as a result of contagion from the US credit market crisis. So the French president should be told that there is no case for the ECB to cut rates pre-emptively, not least because to do so would only help to bail out speculators. The most that can be said at this point is that the ECB should not raise rates at its 6 September meeting. Continuing after- shocks from the summer’s contagion, even the failure of a big financial institution cannot be ruled out yet.

When the credit-market crisis erupted this August the ECB’s enemies were quick to accuse the bank of over-reacting on 9 August. When it became clear that this upheaval had "made in America" plastered all over it and that the world economy could be teetering on the brink, the scale and speed of the ECB’s reaction (even some members of the European System of Central Banks were surprised by the executive board’s swift decision-making), impressed the critics. The ECB’s openness about its activities and its carefully modulated private communications with the money markets and with the top executives of major banks are also being applauded.

So, unless something goes badly amiss in the next few weeks, the ECB’s handling of the summer credit market crunch will have reinforced the convictions of those members of the Eurogroup, the finance ministers of eurozone countries, who believe meddling too deeply in the ECB’s affairs might not be such a good idea. Can you imagine what a mess we would have been in if, in mid-summer, eurozone finance ministers had had to be hauled back from the beaches to debate how to head off a global financial meltdown?

Fortunately, this time, taxpayer-financed bail-outs of mortally wounded banks have been avoided. So, instead of plugging tired domestic political agendas, finance ministers and Sarkozy should be thanking their lucky stars that the ECB, as a recent speech by its Vice-President Lucas Papademos made clear, has been thinking hard about crisis management in a world characterised by excess liquidity, startling financial innovation and unprecedented global integration.

• Stewart Fleming is a freelance journalist based in Brussels.

Further talks aimed at concluding the Doha round of World Trade Organization (WTO) talks will open next week (3 September).

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