The ECB is in a most unenviable position.  As the EMU begins to falter they are confronted with few tools with which to fight this battle.  The market called their bluff yesterday with the Greek bailout and is clearly looking past Greece at Portugal and Spain while daring the ECB to make a move on either country.  The bond “vigilantes” are betting on the fact that the ECB has overplayed their hand with the Greek bailout.  At this point, it looks like the vigilantes are correct.  The ECB put a gun on the table and it turns out to have been nothing more than a water pistol.  Unfortunately for the vigilantes the ECB is not out of tricks.  They have a Hank Paulson like bazooka in their option to buy bonds on the secondary market.  But can they use it?    RBS analysts believe they should not hesitate in acting:

“The ECB should not wait for a renewed deterioration of the periphery before acting. It should regain its leadership in tackling the crisis following a complete communication and coordination failure amongst euro area fiscal authorities around the Greek crisis. Should contagion reappear, there will probably not be enough time to go through a similar backstop facility to that of Greece for the next country. There simply will not be enough time. Better breaking the rule-book than breaking up the euro area!”

Unfortunately, the decision is a bit more complex than the Fed’s decision to buy assets directly from the U.S.banks – what many refer to as “quantitative easing”.  As we’ve previously explained, the Euro is flawed primarily because it is one currency housed under several economies with multiple governments.  They are not truly unified because their economic strategies differ which make their inherent monetary needs different.  Using the same currency for economies as different as Germany and Greece is truly forcing a square peg in a round hole.

Where are the potential roadblocks to QE?   First of all, the program would have to be massive.  Credit Suisse estimates that the cost to bailout Spain, Portgual and Greece could be as high as $600B.  The program would almost certainly have to be as large in order to quell any and all market fears.  But the bigger roadblock is the Maastricht treaty.  Although the ECB could technically use the loophole of the secondary market the surrounding nations would be hesitant to approve such a program that would be rife with moral hazard and potential inflation.  And perhaps the most important roadblock is this: why would Germany ever approve such a measure after nearly balking on what is now viewed as a pitiful $100B package?  Marco Annunziata, chief economist at UniCredit told clients:

“(this is a line) the German government would not allow to be crossed. Purchases of government bonds would be a straight monetary financing of excessive fiscal deficits, which is anathema to the Bundesbank and German government.”

In my opinion, the move to bond purchases would be an admittal that the single currency system has failed.  If these nations are going to allow such bailouts then you have to wonder why they share a currency and risk not only higher inflation, but future misuse of funds?   The Bundesbank would seem to be particularly disgusted by such an option.  And even worse, such a measure would almost certainly come attached with very harsh deficit spending restrictions which would ensure continuing economic pain in the region.  As we’ve learned here in the states, the banks were never reserve constrained and have not picked up their lending despite the massive Fed programs.  Despite claims of victory the Fed is still pushing on a string.  As the bank bailouts have done little to relieve Main Street in the United States it’s unlikely that bond purchases in Europe would do anything to help the Main Street citizens of Europe.

The one thing bond purchases would do is prop up a currency system that has been flawed from its inception.  And with the purchase of bonds the Germans now have to very seriously consider why they are part of such a misguided union which very seriously risks their much needed price stability?   Even worse, the Greeks must ask themselves why they are forcing potential depression on their citizens just so they can appease the needs of their surrounding “union” – a “union” which appears increasingly less likely to support them following yesterday’s market action.

It now looks like the ECB has no choice but to go nuclear.  After all, we live in a bailout world where failure is truly not an option and government intervention is the savior of the “free market”.  With this intervention I believe the Euro currency will officially take its first step into the grave.  The member nations are now realizing that there is little benefit to being in such a “union” when all it does is impose potentially catastrophic risks on each of their citizens.

Surely the Germans must be asking themselves how the Brits could have been so wise to sidestep this whole disaster.  And if they are wise, they will either put their foot down on any bond purchases or begin the process of leaving the union as soon as possible.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

More Posts - Website

Follow Me:

  • teomax

    thats what i wrote here before.
    ECB will use QE in second stage of crises and everybody will be happy.
    QE didnt harm US, Japan or GB much or not at all, just print baby print … The bond “vigilantes” apparently like QE (good luck for them in the future) and the printing could be more easier as every politican and their grandmamma isnt interested in real solutions, just print baby print.
    Current crises wont be over until there is a final deathmach between Bondzilla and Printing Press machine.

  • boatman

    it has started, now there is 3 dead at a bank in athens…..mark this day…the credit crisis becomes soveriegn debt crisis becomes currency crisis just as night follows day.

    when the can they’re kicking finally gets down to the bottom of the hill, dow:gold ratio will be between 1 and 2.

    and i’ve done good in paper the last 20 years,but those days are over for any LONG.

    i’m bookmarking this page, and in 5 yrs. i’ll pull it up here.

    if i’m wrong, the paperguys around here can have at me.

  • Octopus

    From Daniel Gros, Centre for European Policy Studies

    Portugal Next For EU Bailout, Italy Safe, Spain Maybe, Says expert
    2010-05-04 14:03:27.21 GMT

    Brussels (dpa) — Portugal is “quite likely” to be the
    second eurozone country to need an international bailout after
    Greece, Spain could suffer liquidity problems but not a default,
    while Italy is relatively safe, a leading European economist
    said Tuesday.
    Daniel Gros, director of the Brussels think-tank Centre for
    European Policy Studies (CEPS) and former advisor to the
    European Commission on economic and monetary union, said
    Portugal’s situation, “from an economic point of view, is like
    Athens was given a 110-billion euro (146 billion dollars)
    lifeline by euroarea countries and the International Monetary
    Fund (IMF) over the weekend, to help it avoid default on its
    rocketing debt.
    “The Portuguese will need some money sooner or later, I
    think it is quite likely,” Gros said at a briefing in Brussels,
    mentioning 100 billion euros as a ballpark figure.
    Portugal’s gross external debt — a measure of its
    vulnerability to default — reached 226 per cent of its gross
    domestic product (GDP) in the third quarter of 2009, Gros
    Greece’s was 167 per cent, Spain’s 164 per cent, Italy’s 121
    per cent, while in Hungary it rose to 141 per cent in 2008, the
    year the country was bailed-out by the European Union and the
    Gros said Spain was less exposed “because it has a much
    higher domestic saving rate”, meaning that its citizens would
    buy most of its government bonds.
    But he warned that Spanish banks may face a liquidity
    problem if their European counterparts decide they are no longer
    credit-worthy due to the losses incurred as a result of the
    housing bubble going bust.
    In that case, Gros said, the European Central Bank (ECB)
    would have to step in to prevent a meltdown of the Spanish
    financial system.
    The ECB has already intervened to help Greece, saying it
    would accept its bonds as collateral even if they have reached
    junk status, according to international rating agencies.
    “Italy is further away (from the crisis) because they have
    an even higher savings rate so the government can be financed by
    Italians,” Gros indicated.
    But he warned that “in the next decade it could get very
    tough” for the Italians, due to their endemic low-growth
    If Italy’s economy continues growing at a slower pace than
    interest rates, Gros explained, its government will have to keep
    cutting spending or raising taxes to reduce the ratio of debt to
    GDP — currently standing at 115 per cent while euroarea rules
    recommend it stays below 60 per cent.
    “It is like rowing against the current, and after a while
    you get tired,” the CEPS director said.
    The German-born economist also said Portugal could slim the
    chances of an emergency rescue only by adopting preventive
    “tough” austerity measures.
    But he added that they would have little credibility in
    front of the markets if similar measures promised by Greece
    would not be implemented because of a popular backlash.
    “The success of the Greek plan is key,” he stressed.
    In exchange for the bailout, Greece was told to reduce its
    deficit by 6.5 percentage points of GDP in 2010, while in
    February it was told it only needed a 4 point correction.
    Gros said the European Commission and eurogroup were at
    fault then for endorsing “clearly insufficient” cuts, arguing it
    was their laxity which fueled market jitters over Athens’
    insolvency, rather than Germany’s delay in approving the EU/IMF

  • B Ferro

    Great write-up TPC. Well rationalized thoughts.

  • Derfem

    BCE go nuclear. Trichet decide an exception for Greece, and accept greec bonds as collateral.

  • chris

    good post tpc. (you are beginning to find your mojo.)

    keep them coming octopus.

    (i would especially like to see an analysis of the refunding schedules for the pigs…remember, greece went first because of a liquidity problem, as it has big maturities coming due soon…same story for portugal/spain?)