Private sector involvement and lender of last resort in the Euro area: the impossible duality?

There appears to be a major contradiction in the current ECB position regarding
the solution to the current crisis: on the one hand, it insists that “private sector
involvement” (code word for haircut on money imprudently lent to profligate
states) should be rejected as it implies that Euro-area sovereign debt is not risk-
free (meaning credit-risk free)¹; on the other hand it adamantly rejects any ECB
role as lender of last resort for Euro-Area Sovereigns as this would imperil its
inflation-fighting mandate².

The only reason why traditional sovereign debt is credit-risk free is precisely
that monetization can occur as the sovereign can (and regularly does) inflate its
debt away: as it can devalue the currency used to pay back its debt, it does not
need a haircut. If that avenue is closed, then indeed a haircut is necessary and
Euro-area government debt is not credit-risk free: countries have pooled their
monetary sovereignty. As a result, they cannot use it to their private benefit and
to the cost of fellow Euro-area countries, therefore the necessity of a haircut.

This might be an inconvenient truth as the haircut is borne by fellow Euro-area
countries banking sectors, but it’s a truth nevertheless.

¹See 24 Nov 2011 Gonzalez-Paramo’s speech in Oxford: “It (the haircut) signals to investors that assets that were previously risk-free are no longer so, that the euro area is a market where their investments are not guaranteed.”
²Same source: “The ECB is a central bank, committed to its mandate to preserve price stability over the medium term. It is not the fiscal lender of last resort to sovereigns.”