Learning Lessons

The news on the Eurozone is very worrying and depressing. Despite constant statements that EU governments are willing to do "whatever it takes" to save the Euro, the European Central Bank has not been told or permitted to act as a lender of last resort.

It might well be true that badly run countries like Italy and Greece would not reform if the ECB steps in and lends them money without strict conditions. However, by refusing to let bank do this under any circumstances, EU governments are risking these countries defaulting and thereby destroying the Euro.

The main reason that the ECB option is, in Angela Merkel's words, "off the table" is that Germany worries that allowing it to act in this way will cause inflation. Willem Buiter, who is the Chief Economist of CitiGroups calls the German approach "mad". "You can drown in water", he says, "but that does not mean that you shouldn't have a glass of water when you are thirsty". This chimes with Paul Krugman's view that inflation is, in the context of the weak and indebted European economy, the least of the dangers we face (and might even be helpful by lessening the burden of debt).

Germany's experience of hyper inflation in the 1920s was doubtless traumatic. The German authorities rightly drew the lesson from that experience that it is generally a bad idea for governments to print vast amounts of money. However, they are guilty of applying this lesson in a stupidly rigid and indiscriminate way.

On 9-11, many people who had been in the twin towers during the 1993 bomb attack died because they remained in the building waiting to be rescued even though they were in floors below the impact zone. In doing so, they were applying the lesson of the 1993 attacks that, in an emergency in a skyscraper, it is best to wait to be rescued. This lesson resulted from the fact that in 1993 most injuries occurred in the stairwells as people sought to escape.

These people's mistake was to stick inflexibly to a lesson that was no longer appropriate in the exceptional circumstances in which they found themselves. Similarly, while inflation is often a real danger, we are now in truly exceptional circumstances. Germany's insistence that the lessons of and solutions to, its problems in the 1920s must be the applied to our current problems is as misguided and, in economic and political terms, as dangerous. If the German authorities cannot bring themselves to recognise that their specific experience in the 1920s does not hold the solution to all financial and economic problems in all circumstances it looks like the Euro will collapse and with it the world economy.