Outlook: Anyone who needs a back-to-basics primer on why the European Central Bankcannot simply wade into the eurozone crisis to save the day by buying up all the debt that Italy, Spain and the rest need to issue could do worse than reading 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 ECBbuying sovereign debt of national countries, which is used and seen as a mechanism for financing the current account deficit of those countries, whichinevitably, if things go wrong, will create liabilities for the surplus countries".
Sir Mervyn's point, in case that's not clear enough, is that the ECB's backers, the member states of the eurozone, will incur losses if their central bank makes loans on which borrowers subsequently default. The ECB should not be lending to the eurozone's cash-strapped countries because to do so wouldexpose all member states, including those not in financial difficulty, topotential 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 theexposure is really no different. But it really should not be the job of the European Central Bank – or any other central bank for that matter, which may be why Sir Mervyn was so keen to offer support yesterday – to step in where national governments are afraid to tread for political reasons.
What does that mean for the current impasse in the eurozone? Broadly, it means 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 following the general election this coming weekend.
In both cases, however, bondmarket 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, pictured, 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. Is she prepared to put more German money on the line in the knowledge that doing so will damage her chances of re-election a few months later? If not, Ms Merkel may yet be paying for her campaign materials in deutschmarks rather than euros.