Trichet Exit During Crisis Leaves Legacy in Balance
Jean-Claude Trichet was the man to call in Europe.
In the days leading up to the first grand European bailout in May 2010, U.S. Treasury Secretary Timothy F. Geithner called Trichet five times, once five minutes after his daily briefing with President Barack Obama, according to his calendar. Eighteen months later, French President Nicolas Sarkozy left his wife in labor to force a mini summit at Trichet’s farewell party in Frankfurt.
Trichet, whose eight-year term at the helm of the European Central Bank ends on Oct. 31, was “the great crisis manager in Europe,” says his colleague on the ECB’s Executive Board, Juergen Stark. “His role extended beyond the ECB because there was a vacuum. There was no political leadership in Europe. He became the leader who warned, admonished and urged politicians to do the right thing.”
While Trichet’s activism has held the 17-nation currency bloc together as elected leaders procrastinate over their response to the debt crisis, it has come at a cost to the ECB. The 68-year old Frenchman has torn up the manual he helped to draft and alienated the ECB’s German policy makers by taking the central bank into the uncharted territory of bond purchases. Even Stark, whom he describes as a “very close friend,” has tendered his resignation over the bond buying.
‘The Man Who Saved The Euro?’
“Trichet may one day be seen as the man who saved the euro,” says Tobias Blattner, a former ECB economist now with Daiwa Capital Markets in London. “He could also go down in history as the president who sold the ECB’s independence to do it. With the crisis still in full flight, it’s too soon to say what his legacy will be.”
Trichet, who will hand the reins to Italy’s Mario Draghi, had a presidency of two halves. The first was spent in relative orthodoxy, fine-tuning interest rates to keep inflation around the ECB’s target of just less than 2 percent. Even the arrival of the global financial crisis in 2007 and the collapse of Lehman Brothers Holdings Inc. in 2008, which prompted Trichet to flood Europe’s banking system with cheap cash, were economic challenges he met without flinching.
The sovereign debt crisis took Trichet out of his comfort zone, forcing him into policy U-turns, dividing the 23-member Governing Council and raising the possibility that the euro -- for Trichet an historic milestone on the road to European unity -- could fail.
The crisis, which began with Greece admitting in October 2009 that it had underestimated its budget deficit, has taken Athens to the brink of default and undermined confidence in other highly-indebted euro-area sovereigns as well as the region’s banks, who face massive losses on their bond holdings.
As the meltdown sent bond yields soaring to euro-era records and prompted credit-rating downgrades, the ECB was forced to loosen its lending criteria, reintroduce longer-term loans to banks and, finally, cross the Rubicon and start buying government debt on the secondary market.
“It had to safeguard financial stability and could not allow the financial system to collapse,” says Lucas Papademos, Trichet’s vice president until May last year. “The ECB’s interventions in sovereign bond markets should not be perceived or interpreted as a ‘freebie’ for governments. They are temporary. Governments cannot assume or expect that the ECB will always facilitate their funding independently of the achievement of their fiscal and other policy objectives.”
Yet 18 months after first insisting the purchase program was a short-term measure, Trichet leaves office with the ECB buying Italian and Spanish debt on a weekly basis to keep the nations’ borrowing costs down.
The rationale is that the purchases ensure the proper transmission of the ECB’s interest rates. German policy makers have criticized the tool, saying it comes close to bailing out profligate governments.
The bond buying prompted the resignation of ECB chief economist Stark and led to the eventual departure of former Bundesbank president Axel Weber, once the leading candidate to succeed Trichet. It is also opposed by current Bundesbank President Jens Weidmann.
People who worked with Trichet say the bond-market intervention was probably the hardest decision he had to take in his eight years at the ECB’s helm.
Tears of Frustration
In the run up to the first Greek bailout in the spring of 2010, Trichet was close to tears of frustration on a number of occasions as Germany and France bickered over how to rescue Greece and prevent contagion while limiting their own taxpayers’ exposure, according to an ECB official who spoke on condition of anonymity. Trichet felt he was the only one prepared to act to save the euro. The ECB started buying bonds in May last year.
“For Trichet’s legacy, the last two years have been woefully bitter,” says David Marsh, author of The Euro, The Battle for the New Global Currency. “He’s become the central actor in other people’s drama, the focus and the victim of the politicians’ mind-boggling incompetence in running the euro.”
The crisis has given a new lease of life to the naysayers, particularly in the U.S., who before the euro even began trading in 1999 questioned whether a common currency could ever work without a common fiscal policy.
Among the euro skeptics was Harvard Professor Martin Feldstein, who wrote in a 1998 paper that monetary union would prove an “economic liability” because divergent economies couldn’t fit under one monetary roof. Milton Friedman, the Nobel Laureate who died in 2006, said it was “highly unlikely” to succeed and would splinter as soon as the “global economy hits a real bump.”
More recent doubters in the U.S. include Pacific Investment Management Co. Chief Executive Officer Mohamed El-Erian and Nouriel Roubini, chairman of Roubini Global Economics LLC, who say the euro area has to shrink to survive.
The gap between French and German 10-year bond yields, at 93 basis points, is wider now than it was before the euro was introduced.
For Trichet, the euro is more than an economic experiment. It is an historic endeavor to further unite Europe’s varied nations and help them live together in peace.
“For the generation that lived through the Second World War, Europe was essential to prevent a return to the depression and the horrors of that war,” he said when receiving the Charlemagne Prize for European Unity in June.
“For the generation after, Europe was the cornerstone of building prosperity through economic freedom and open markets. For the current generation, these achievements are taken for granted. Citizens have new concerns.”
Trichet’s job was made more difficult when Germany and France watered down the euro’s fiscal rulebook, the Stability and Growth Pact, against his wishes in 2005. That allowed them to escape sanctions when their budget deficits exceeded the limit of 3 percent of gross domestic product, paving the way for more fiscal loosening among the euro’s member states.
“The project is primarily political in nature, so you would have hoped the politicians would be less negligent in safeguarding it,” says Marsh. “It’s not Trichet’s fault, he deserves credit for great effort in the face of adversity.”
Some say Trichet also made mistakes.
While the ECB was the first central bank to flood financial markets with cash to avert a credit crunch in 2007, Trichet “underestimated” the threat the U.S. housing slump posed to the euro area, says Marco Annunziata, chief economist at GE Capital in San Francisco and a former International Monetary Fund official.
Tightening Amid Tension
Trichet kept “insisting that what we were seeing was a purely U.S. crisis” and that since “emerging markets were decoupling and there were no external imbalances, the euro zone was insulated,” Annunziata says. That “culminated in the rate hike in July 2008,” which “will have to be seen by posterity as one of the most flagrant policy mistakes during the crisis.”
The ECB raised interest rates in 2008 when the global financial crisis was intensifying, only to three months later embark on the most aggressive series of cuts in its history in the wake of the Lehman bankruptcy. This year, the ECB raised borrowing costs twice even as the debt crisis worsened.
The ECB’s “narrow” mandate forces it to pay too much attention to prevailing inflation at the expense of economic growth and financial stability, says Richard Hoey, chief economist at Bank of New York Mellon Corp. in New York, who predicts the central bank will again be forced to change course on rates as soon as next month.
‘I Scratch My Head’
“I look at the ECB policy and I scratch my head,” he says. “The ECB is making a monetary policy mistake. The risks of recession are rising daily because of the delay in adopting an appropriate policy response to the stresses. If Ben Bernanke were running the ECB, he’d cut the policy rate by 50 points tomorrow morning.”
Bernanke’s predecessor at the U.S. Federal Reserve disagrees. “Trichet, in my judgment, is one of the world’s most effective central bankers,” says Alan Greenspan.
Inflation averaged 2 percent during Trichet’s reign, narrowly missing the ECB’s target. Growth averaged 1.1 percent, while euro-area unemployment rose to 10 percent from 8.9 percent when he began in 2003.
During his final speech on Oct. 24 in Berlin, which was disrupted by students protesting about the debt crisis, Trichet was confronted by a woman.
“Could you live on a wage of 470 euros ($655) a month?” she asked. Trichet replied that the “main issue” policy makers face today is ensuring “that we are as close as possible to giving a job to all our people, including our young unskilled people.”
‘A Big Fire’
Yet Trichet may be better remembered for his crisis management than his economic ambitions.
“There was a big fire, the question was how do you contain it?” says Pascal Lamy, World Trade Organization Director- General and a long-time friend and colleague. “Trichet had to take a federal stance. The ECB is the only institution that can react quickly.”
Trichet became so central to the battle against the debt crisis that European leaders turned an event to honor him on Oct. 19 into a mini summit. Sarkozy, whose wife was giving birth to their daughter that night, jetted into Frankfurt to convene with Trichet, German Chancellor Angela Merkel and a host of other policy makers.
Speaking at the event, former French president Giscard D’Estaing, one of the founding fathers of the euro and a close friend of Trichet’s, challenged the critics.
“Who among those who criticized you could have achieved a better result?” he said. “The euro thanks you, Jean-Claude Trichet.”
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