The European Central Bank, now led by Mario Draghi, must accept its role as the lender of last resort in Europe and promise unlimited and liquidity for sovereign bonds.
That is the silver bullet needed immediately to save the euro and prevent global recession, argues Alexander Friedman, chief investment officer of UBS, in an article in the Financial Times.
Its limited and temporary support offered so far has left sovereign bonds of countries like Italy and Greece vulnerable to weak demand and speculative attacks, he writes. Only unqualified support will stop the panic raging through euro zone bond markets, and the ECB is the only institution that can offer such an unlimited backstop.
The most important lesson of the Great Depression was to highlight the importance of the lender of last resort, says Friedman, former chief financial officer of the Bill and Melinda Gates Foundation. The 2008 financial crisis in the U.S. again showed that lesson when the Federal Reserve stopped panic by declaring itself the lender of last resort.
The only permanent solution may entail some sort of fiscal confederation and the issuance of euro bonds, Friedman says. But that will take time, and only unlimited bond backing from the ECB can deliver time.
Unfortunately, the central bank remains obsessed with inflation due to Germany's hyperinflation of the 1920s. Yet the threat of inflation, Friedman says, is not an issue now.
Many economists agree with Friedman. History has shows that being the lender of last resort is a crucial function of central banks, writes economist Paul Krugman in a column in The New York Times.
For instance, the Federal Reserve was created after the U.S. had to rely on JPMorgan to fill that role in the panic of 1907, he says. Yet the ECB clings to the theory that its job is only to combat inflation.
"This amounts to a radical theory at odds with evidence and experience. And it’s a theory that could kill the euro," Krugman writes.
The ECB has so far ruled out being the lender of last resort, saying it is legally lacks that power.
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