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Thursday 17 November 2011

Germany’s Last Resort

Would Douglas Adams have called the bank at the end of the Eurozone Milliways? Millibank? Whatever. While the usual suspects drone on about loss of democracy in Europe (clue to clueless pundits: no election has been cancelled or even deferred thus far), the German Government, headed by the ever-cautious Angela Merkel, is resisting the inevitable.

And that inevitable thing is that the European Central Bank (ECB) becomes the Eurozone’s lender of last resort. Merkel’s reluctance is entirely understandable: the great inflation of the early 1920s is burned on the German psyche far deeper than the fear of another Great Depression in the USA, or indeed severe inflation in the UK, despite the latter being well within living memory.

But banking models that have endured since the 17th Century suggest that the Germans are this time on the wrong side of reality: Sterling has, since 1694, had the Bank of England (BoE) as its lender of last resort. It is the UK Government’s banker, but crucially the BoE is responsible for the currency, and maintaining confidence in it. The currency is still around over 300 years later.

Looking across the north Atlantic, the Federal Reserve (or just The Fed) is, equally, lender of last resort for the US Dollar. The USA, where states enjoy a significant degree of autonomy, may prove instructive for Germany: the Fed was set up partly in response to a series of banking crises and intended to act against bank runs. Crises and bank runs are what the Eurozone is facing right now.

Nevertheless, the German response is to refuse to allow the ECB to go the same way as the BoE and the Fed, and push instead for fiscal integration and reform. But if there is no lender of last resort, the markets will keep on teasing out the weakest links and betting on them falling. So the crises and bank runs will continue – until the Eurozone has what the UK and USA have had for decades.

The alternative – to keep kicking this particular can down the road – will merely invite more speculation, more uncertainty, more instability, less growth, potentially more unemployment, together with a growing number of dissatisfied electorates. That direction may lead to the single currency collapsing. The Germans don’t want that. So they need to ask themselves one question.

And a stable banking system does not depend on whether you feel lucky.

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