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Richard Portes's outspoken enthusiasm for euro falters

One of the euro's last optimists is ready to throw in the towel.

For more than two decades, the single monetary union has had no more steadfast an advocate than prominent economist Richard Portes, a professor at London Business School and an expert on European monetary, fiscal and sovereign debt issues.

Not any more.

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"We are heading towards kind of a slow-motion train wreck," a gloomy-sounding Prof. Portes says from his London office. "You can see what the big wall is up there, and nobody is doing anything sensible about it. It's just a disaster."

Two things have finally soured him on the euro's prospects. One is the wave of ill-advised austerity policies that have triggered another recession and are about to make economic conditions a whole lot worse.

Second is the stubborn refusal of policy makers to turn the European Central Bank into a credible lender of last resort.

"I'm very, very upset about it, but that's where we are."

As Europe's deepening debt crisis rattles markets, brings some countries to the brink of ruin and casts a dark shadow over the euro's future, Prof. Portes is part of a growing chorus clamouring for the ECB to take a more activist role in stabilizing public finances, restoring order in the markets and stopping the contagion.

British Prime Minister David Cameron did a solo rendition recently, saying he simply didn't understand "why some in Europe are so opposed to being more of a monetary activist." Most bond experts agree that speculators attacking Italian, Spanish and now French bonds would quickly retreat if the ECB put a cap on rates by signalling it was prepared to buy unlimited quantities of the affected assets.

But even as the ECB resumes purchasing limited amounts of troubled government bonds in the secondary market, it continues blithely marching on to a tune largely orchestrated by Germany, which remains virulently opposed to any expansion of the central bank's role in cleaning up the mess. Two German members of the ECB board have already quit in anger over its previous modest purchases of government debt. And German policy makers turn apoplectic at the thought of more intervention.

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Their long-held view, restated last week by Bundesbank chief Jens Weidmann, who naturally wields considerable influence at the Frankfurt-based ECB, is that creating money would stoke inflation and encourage more bad behaviour from politicians who would rather not upset voters by slashing budgets and boosting taxes to rein in soaring deficits. It "undermines the incentives for sound public finances," Mr. Weidmann intoned.

In the current crisis, it's an argument that is without merit, argues Prof. Portes, who will explain why he has turned so pessimistic on the euro-zone's prospects at a breakfast gathering of the Economic Club of Canada Tuesday morning in Toronto.

The fear that an interventionist ECB will set off inflation "is just madness," he says. Inflation expectations remain below the bank's target range of 2 per cent. And the euro-zone economy is sliding back into recession, which will further dampen prices. The European Union has dropped its own forecast for 2012 to a mere 0.5 per cent growth from its previous prediction of 1.8 per cent.

And as for fostering bad political habits, well, it's a little late in the day to be worrying about the lack of fiscal discipline in a Greece or Italy.

The markets urgently need "the explicit assurance" that the central bank will set a ceiling on Italian and, if necessary, Spanish government bond interest rates, "in recognition of the fact both are solvent. They have a lot of work to do still, but they are solvent. I would not suggest that the ECB should say that about Ireland, Portugal and certainly not Greece, obviously."

Greece is already heading toward certain default, with Ireland and Portugal following, he says.

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Efforts to use a ramped- up version of the European Financial Stability Facility to accomplish what the ECB is unable or unwilling to do are doomed to failure, Prof. Portes adds. "No financial engineering with the EFSF is going to make any difference. And I think the markets understand that."

Even if policy makers manage to do what needs to be done to stanch the bleeding, they will still have to come to grips with the longer-term problem of a lack of fiscal and financial integration within the euro zone. That will require strong political will, which so far has been noticeably lacking.

But for now, their focus has to be on Italy and its spiralling financial woes. Rome already faces interest rates that are unsustainable over the long term, given low inflation. "As soon as that is generally recognized, we're going to have the mother of all bank runs."

This nightmarish outcome can still be prevented, but the Europeans are running out of time.

"If Germany effectively says it is politically impossible for the ECB to act as lender of land resort [a position strongly taken by the ECB itself] then I regret to say that the euro is toast. That was not my feeling even a few months ago. I think the political leaders have just taken us down a very bad track."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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