I am quite disappointed in John Hathaway. Though I do believe that the redrafting of the Stability and Growth Pact will have a positive effect on gold as it will weaken the Euro somewhat, some of his statements are simply incorrect and reflect a disconcerting American bias.
"We have long believed that the euro is more deeply flawed than the US dollar. It was only a question of when the market perceptions would reflect reality. As noted recently by James Grant of Grant’s Interest Rate Observer: “The soundness of a central bank varies inversely with the breadth of its mandate… Since the ECB has one charge---price stability---it must be reckoned a better bet to succeed than the multi-tasking Fed”. Too bad this excellent article went to press on February 25th. The ink was barely dry on Grant’s litany of reasons to doubt the credibility of the euro, when the Europeans proved the point. Political exigencies (unemployment, stagnant GDP) prevailed on European technocrats to “loosen the rules”, effectively rewriting the mandate for the euro to include “economic growth” along with price stability."
No change in mandate for the ECB has taken place. Yes, the rules have been loosened in certain instances. Yes, it will place fewer restrictions on governments regarding their deficits. Does it mean a free for all? Not at all!
To contrast, how many restrictions are there on the U.S. deficits? The reality is, based on CalculatedRisk's analysis of increased government debt, that the U.S. currently runs a fiscal deficit in excess of 5%. There are no procedural limits to increased spending on congress that I know of! At least in Europe there still are, though clearly, they are not as stringent as before.
The fact is that NO European government is in charge of the Euro. Because no single government can apply pressure to the ECB, it makes it much easier for the ECB to execute on its simple mandate of price stability. With the ECB there is a clear separation of budget (in governments hands) and management of the Euro money supply. As has been demonstrated several times over the past five years, the ECB has not bowed to pressure from even the most powerful EU members, German and France, with regard to lowering interest rates.
As can be seen from the Trichet statement in the following article, he is quite determined to use the tools at his disposal to defend the Euro:
"This is necessary in order to anchor expectations of fiscal discipline, which is fundamental not only for macroeconomic stability and cohesion in the euro area but also for enhancing confidence and fostering growth prospects in all member states," he declared.
His words seemed intended as a signal that the ECB is prepared to apply rigorous medicine to underpin the euro to compensate for any political reform of the pact judged by the bank as a threat to credibility.
In doing so, he appeared to suggest, the ECB would protect the fundamentals of the euro, including the credibility of the ECB itself.
The fact is that the ECB is quite independent and has enough levers to force countries into reasonable discipline if it needs to enforce its mandate. The threat mentioned below that markets might begin to price selectively bonds issued by eurozone governments with structural deficit problems will also help to keep governments spending in line.
Here is the article from Agence France that sheds some more light on this issue.
Agence France Presse -- English
March 14, 2005 Monday 5:39 PM GMT
ECB guarantees to uphold euro if Stability Pact is watered down
The European Central Bank waded into tense political talks over eurozone budget rules on Monday, signalling it was ready to use interest rates to counter any undue slacking and reassure financial markets.
ECB chief Jean-Claude Trichet warned that markets could react against marked easing of the deficit rules by pushing up interest rates or selling the euro.
His comments to the economic and monetary affairs committee of the European Parliament about ministerial talks aimed at redrafting or re-interpreting the Stability and Growth Pact were notably blunt.
He declared: "I think that the credibility of the ECB might play a role in convincing markets that they can trust us whatever happens in the realm of the Stability and Growth Pact".
Trichet, referring to ECB monetary policy, said that "we see the current level of rates as appropriate", adding: "Everybody knows that if we would need an increase of rates we would do that without hesitation."
However, he declined to specify how the ECB would react to changes in the pact, saying: "We will make our final judgement on the basis of the final decision.
"The credibility of the excessive deficit procedure as a means to deter and correct excessive deficits needs to be fully preserved.
"This is necessary in order to anchor expectations of fiscal discipline, which is fundamental not only for macroeconomic stability and cohesion in the euro area but also for enhancing confidence and fostering growth prospects in all member states," he declared.
His words seemed intended as a signal that the ECB is prepared to apply rigorous medicine to underpin the euro to compensate for any political reform of the pact judged by the bank as a threat to credibility.
In doing so, he appeared to suggest, the ECB would protect the fundamentals of the euro, including the credibility of the ECB itself.
Trichet said that discussions on reform of the pact "now need to be brought to a convincing conclusion with an outcome that safeguards fiscal discipline".
In a reference to the ECB and its statutory duty to ensure price stability, he said: "Our life will be totally different if the result (of ministerial talks to redraft the pact) is a good result or if it is a bad result.
"Our responsibility will be exerted in a different environment," he said, signalling that marked relaxation of the rules would be a burden for monetary policy and would certainly push up interest rates on capital markets.
The rule limiting a country's public deficit to 3.0 percent of output and the excessive deficit procedure for breaches should not be weakened, he said.
Trichet signalled that the ECB would look favourably on changes which strengthened incentives for governments to make extra efforts to strengthen their public finances when growth and tax receipts were strong.
He said that so far the exchange rate of the euro and European capital markets had scarcely been affected by an increase of public deficits in several eurozone countries or by the debate about the pact.
However, Trichet said he wanted to draw attention to the fact that financial markets could accumulate tensions and then give expression to them.
There has been some market comment recently that markets might begin to price selectively bonds issued by eurozone governments with structural deficit problems, thereby pushing up yields on those instruments and therefore long-term interest rates.
Financial penalties against countries breaching the rules, notably France and Germany, have been effectively suspended by EU ministers.
The ECB chief received support from Belgian Finance Minister Didier Reynders who said outside a meeting on the euro and consumers in Brussels that current proposals for the pact were workable but that "to go any further would probably endanger the credibility of the eurzone... we are at the limit of what is possible".
The key ECB rate has been at the historically low level of 2.0 percent since June 2003.
Trichet said this was because of "relatively contained underlying inflationary pressures". Low rates had given significant support to economic recovery. But they had also stimulated strong monetary growth since the middle of last year and vigilance was required regarding the resulting inflationary impact.
He expected growth in the eurozone to be moderate this year and next. Investment, exports and domestic consumption were expected to grow this year.
The ECB continued to see no evidence of domestic inflationary pressures in the eurozone, but oil prices continued to pose a threat of inflation.
"Risks to price stability over the medium term remain on the upside, requiring continued vigilance. Such risks continue to be associated mainly with oil price developments, uncertainty regarding future increases in indirect taxes and administered prices, and potential second-round effects stemming from wage and price-setting behaviour," Trichet said.
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