David Prosser: Sir Mervyn spells it out: ECB cannot ride to the rescue

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The Independent Online

Anyone who needs a primer on why the European Central Bank cannot simply wade into the eurozone crisis by buying up all the debt that Italy, Spain and the rest need to issue could do worse than read the remarks made by Sir Mervyn King yesterday. Being a "lender of last resort", said the Bank of England's Governor, "is a million miles away from the ECB buying sovereign debt of national countries, which is used and seen as a mechanism for financing the current account deficit of those countries, which inevitably, if things go wrong, will create liabilities for the surplus countries".

Sir Mervyn's point, in case that is not clear enough, is that the ECB's backers, the member states of the eurozone, will incur losses if their central banks make loans on which borrowers subsequently default. The ECB should not be lending to the eurozone's cash-strapped countries because to do so would expose all member states, including those not in difficulty, to potential losses.

One can quite understand why governments in countries such as Germany might be prepared to accept the risk. For Angela Merkel, lending via the ECB is a much less visible commitment than asking German taxpayers to subsidise the periphery directly, even if the exposure is really no different. But it really should not be the job of the European Central Bank to step in where national governments fear to tread for political reasons. Over to you, Ms Merkel.

Italy's new Prime Minister, Mario Monti, and his technocratic cabinet will no doubt do their best to convince the markets that the eurozone's third-biggest economy can get on top of its debt pile. In Spain, we will know more about the outlook after the general election this weekend.

In both cases, however, bond market investors will not lend money at affordable rates unless a credible back-up plan is put in place – a facility to repay them in the event that Italy and Spain prove unable to do so.

The ECB, for the reasons Sir Mervyn outlined yesterday, cannot be that facility, which leaves only the European Financial Stability Fund. And while it may be able to attract foreign support, one can hardly expect the Chinese, say, to put their hands in their pockets, unless the strongest members of the eurozone have already done so.

And so the brinkmanship continues. Both Spain and Italy have very significant funding requirements in 2012. Ms Merkel, meanwhile, faces a general election in 2013. Will she put more German money on the line in the knowledge that doing so will damage her chances of re-election? If not, Ms Merkel may yet be paying for her campaign materials in deutschmarks rather than euros.