Most European bonds have become toxic. The risk of contagion is increasing as yields are not only rising for troubled countries like Italy and Spain, but also in core countries such as France and Austria. The ECB is likely the only institution with enough firepower to stem the crisis, but it comes from a complicated past and there is dissent amongst its current members as to what role it should ultimately play. Its sporadic purchases of bonds thus far has done little to instill confidence back into markets. The ECB faces a difficult question: stabilize the region and risk future inflation, or maintain its independence and risk a potential breakup of the Euro. The latter likely poses a greater risk, but only time will tell.
At a mid-July meeting of the European Central Bank’s governing board, the bank’s longtime president, Jean-Claude Trichet, was summoned from a conference room to take an urgent call from Berlin. It was Angela Merkel. The German chancellor and French President Nicolas Sarkozy were about to meet in Berlin to deal with Greece’s debt crisis and were at odds over what losses investors might be forced to take. They hoped the ECB could broker a compromise. “They want me to go to Berlin,” Mr. Trichet told ECB colleagues when he returned from taking the call. He demurred, worried about thrusting the central bank deeper into the political realm and risking its independence. In the end, however, he and his central-bank colleagues reached a conclusion that has defined their approach to the two-year-old euro-zone crisis: The danger of not helping outweighed the risk of entering the political fray.
Read the rest in the Wall Street Journal.