THE ECB TO THE RESCUE?
The big rumor driving markets in the last 24 hours is the idea that the ECB will step in as the lender of last resort in Italy once the austerity bill is officially passed. It’s a hilarious quid pro quo – you crush your economy through austerity and we’ll buy a few bonds to ease market fears. Danske Bank has some details on the timeline here:
“The development in Italy will continue to be focal in the coming week. It is key that the austerity bill (EUR60bn) will pass in the lower house. The vote is set to take place on Sunday. We expect the ECB to step up its buying on Monday, once Italy has done its part. It is possible that the ECB will send out a statement on Sunday evening in which it recognises Italy’s last move, as was also the case in August. Back then, when Italy and Spain were included in the Securities Markets Programme (SMP), the ECB successfully pushed 10-year yields from around 6.5% to under 5%. The purchases were massive in the first 7-day period (EUR22.5bn). However, this time the purchases are likely to be even bigger, say +EUR30bn in the first 7-day period. It is essential that the ECB sends a clear signal that it is committed, as it will be tested by the market repeatedly. PM Berlusconi is expected to step down once the bill has passed. We still don’t know whether Italy will go for a general election or whether a national unity government will be formed. This week President Napolitano announced that Mario Monti (former EU commissioner) has been named senator for life, which would make it easier for him to lead a “technocrat” unity government. If this gets broad support it would be the ideal solution from a market point of view.”
Will this work? It depends. If the ECB came out and said: “we are a buyer of Italian bonds at 6%”, then yes, this will work. But they won’t do that. Instead, they’ll likely repeat what they did in August where they buy EUR20B+ bonds, yields sink and then EMU leaders crawl back into their corner where they can watch everything start to meltdown again. As we now know, austerity and tepid bond buying is not the fix. Austerity without growth improvements leads to a worsening budget situation. Have we learned nothing from recent experience? And Italy’s growth prospects are particularly atrocious (see here). The odds of them growing their way out of this catastrophe is practically nil. So, the only real fix here is for the ECB to step in as THE buyer. That or a Euro bond/central treasury solution. In other words, you have to eliminate the solvency issue in Italy. I don’t think the Germans are willing to unleash the bazooka that is required here. Jurgen Stark made that VERY clear earlier this week. Their long standing fears of inflation override all of this.
So, we’ll wait and see what happens in the coming week, but I am fairly certain that nothing has been resolved and nothing will be resolved. The Europeans are in denial over what is required here and their inability to work together is now on full display for the world to see. I believe they should move towards fiscal union, but I don’t for a second underestimate the potential risk of a dissolution of some sort. At times I claim to be able to predict the madness of crowds, but I would never pretend to be able to predict the madness of politicians.
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.
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Is there some operational aspect of the ECB that can’t emulate the Fed in terms of asset purchases (i.e. as pointed out here on TPC, the IOR paid on reserves has kept money velocity at 0, even while expanding the Fed balance sheet)? I’m wondering why with the Fed proof point it hasn’t allayed their fears of “printing”. Or maybe they really ARE preparing for core Euro … and without Italy.
Wait, what happened to Greece? Did someone buy them already? You’re going too fast.
” At times I claim to be able to predict the madness of crowds, but I would never pretend to be able to predict the madness of politicians.”
DANG! that is a great way to say it. did you make that up? if so, I’ll attribute it to you (as I will use it often in the future).
kindest regards, -gordo
Cullen,
If the ECB were to start buying up the debt of the struggling members without obtaining control of the issuers finances:
1. Would this not lead to continued abuses of spending and borrowing by the perhipheral nations with no consequences?
2. While this could be a short-term positive, what are the unintended consequences of the ECB buying in the bonds when they have no cetral treasury?
should have read “central”
The only thing growing in our economies is the level of self-delusion.
We have the answer to the solution and we seem to have diagnosed the disease to solve it. That’s Key.
But I do wish we could also adress the fundamental problems, people and policies that have brought all of us here to the TPC to get to know each other.
In my state…we can cut the school day down to 3 hours a day 2 days a week. Fire all but 5 teachers to teach 100 children. Increase taxes directly or submissively and yet the bureaucracy and the pensions that come with it we can not touch. Thus business and residents vote with there feet. And like a bad HOA those left pick up the bill until the system no longer works. Try clawing back what was promissed and paid out. I’m not referring to Austerity. I’m referring to as Miliken mentioned in your post yesterday Cullen…give money to those who will protect it. Not to FIRE…thus a component of any fix in the U.S or Europe must re-direct money for future prodcutivity(not wall st. version of firing 10 people for one to do the work so the top can hit performance targets–Kevin Sharer you dick)I would encourage solutions but here in the U.S it would have an element of pain that would discourage the same old policies our politicians/executives have benefited from at the expense of the citizens.
Thus while we are not reserve constrained…I would like what ever money is in the system to go to those who will protect it like it means something to others. And those that have shown they don’t know how to…we encourage a system that gives them exactly what they sowed.
Lee Quaintance & Paul Brodsky say it better—was just reading this after. Rhetorical but..why can we answer this and those who slept comfortably in Cannes can’t.
“Very few still pretend the commercial marketplace and financial asset markets are free. Current events confirm we have been trained to think our fortunes are in the hands of politicians, who in turn are caught between competing incentives. Are they supposed to make economic decisions as public servants, per the best long-term interests of the majority in their republics? Or are they supposed to make decisions based on appeasing powerful Interests funding their economies (and often their campaigns) in the here and now? And exactly when are they supposed to ask themselves the deeper question: why aren’t the two the same?”
This policy would be a mess. Austerity will lead to lower levels of production. On top of that this would also lead to a drop in Italian incomes making the real debt burden that much worse. This will lead to a simultaneous drop in both supply and demand inevitably leading to recession/depression. Ironically as long as the drop in incomes outweighs the drop in supply or at least declines at the same pace, the ECB may still be able to hit their objective of an ever increasing price level of 2%. This is why I see targeting a price level as futile because it does not account for why the price level is increasing/decreasing. The change in relative prices are irrelevant compared to the trajectory of the economy.
On top of that, investors may see the bond purchases as price positive which could lead to a temporary rise in intermediate and final goods relative to incomes. This will only work to squeeze the private sector that much more.
I hope that my understanding of economics is so terribly flawed that this outcome becomes total incorrect.
ZH has an excellent one on how Europen banks plan to dump tons of Italian bonds and other sovereign junk into the ECB.
http://www.zerohedge.com/news/sold-you-european-banks-quietly-dumping-€300-billion-italian-debt
This will overwhelm the ECB little capital resources. Will Germany opt out from the Euro zone or approve the running of the printing press (I.e., let the ECB become the lender of last resort)? And move the EU closer to a huge pool of undifferentiated sovereign debt?
Bet you German citizens won’t be too happy about their kids inheriting all that debt. These are the only alterntives:
Breakup or the United States of Europe.
I think the people of Europe are not ready for the later. I place my bets behind breakup which of course means the opposite may happen:-)
” At times I claim to be able to predict the madness of crowds, but I would never pretend to be able to predict the madness of politicians.”
Yeah, change your name to Cullen Newton. Did you loose your shirt with your investments like he did?
Look at you with the clever insult! Time to go back in timeout for the young Casanova! I’ll let you out when you can play nicely with the adults.
grammar alert … “lose”, not “loose”
This is pathetic…the market, the collective wisdom of ws like entities (the new head of the eeu a former gs employee) are instructing us on how to fix the problem while the market rallies in a vote of confidence as rates decouple. It is hystria driven by the hope of forgiveness while the black hood is being drawn over the head.
I to wish that the debt would simply go away, that you can create an entity that has the power to purchase bonds and the debt burden disappears and everyone is lifted inti the arms of productivity but the consequences of deflation followed by inflation are real.
The only question that matters for the EU is whether the ECB continues to engage in tactical purchases of periphery bonds, or whether it goes strategic and makes the market at a designated interest rate. The ECB allowed Italian 10 year debt to exceed 7% to demonstrate to the Italians that structural economic reforms are necessary, and that the ECB (and the Germans) aren’t bluffing. Delaying early retirement ages and sending useless bureaucrats home to find jobs in the productive private sector is “austerity” only to Keynesian fever-dreamers and the left. I think that the ECB goes big on a tactical basis on Monday as a tactical reward to the Italians, but if the Italians waver on reforms, the spigot will be turned off again.
Because of the basic definition of GDP, any actual cut in existing government spending results in a contraction in reported GDP. During the Asian crisis in the late 1990s, I recall that South Korea (as an example) suffered a horrendous year over year drop in GDP. And yet within a year or two it was growing again, and in a few years it was better off than ever in terms of GDP. Other Asian crisis countries shared the same happy outcome. Japan is the Keynesian contrasting example in Asia of perpetual can-kicking via monetary policy to avoid structural reforms.
MMT describes monetary and banking reality, and it has predictive capacity; I’m a confirmed believer. However, contemporary Keynesianism is a blend of monetary policy and leftist social policy prescriptions enamored of bureaucracy and welfare that obviously aren’t working for the USA. Handouts that sustain idleness and bind dependent voters to the source, justified as sustaining aggregate demand, are toxic to a productive economy.
JWG…so you remember when Asia went through its austerity programs…perhaps you should also recall the economic environment at the time. Christ it just as insane to think that you can study the northern hemispheres ecosystem and conclude you understand the ecosystem of the planet. Sadly this is how a conservative views anything in their lives. Perhaps it’s why so many conservatives are forced out of closets.
I don’t have time to educate yet another conservative in all that you don’t understand concerning the rest of the economic world in which you seem completely blind of. Economic systems are complex systems involving human behavior and no economic theory has been developed to adequately extrapolate human behavior. Until this can be done MMT or Keynesian or Klugenometrics or whatever the hell you want to call it are simply divining rods, particularly as you enter into the inflection point or the ‘event horizon’ of a long and poorly managed economic supercycle not seen since the great depression. Application of a particular economic theory within an economic cycle simply supports the underlying theory. When it truly matters…all economic theory fails in its practical application.
Quark, there is a lot of emotion in your response but no analysis; just a lot of overheated rhetoric. Yawn. I suppose that I do not have time to educate another naive Keynesian fever dreamer in the reality of the need for a productive private sector that is large enough vis a vis the public sector so that it can support the welfare states that have made workers lives better, but now threaten to overwhelm the private sector. MMT acknowledges that inflation can and will occur once government spending overwhelms the productive capacity of the issuing nation. Japan and the USA are far from that point, but other nations are not.
Greece is now a currency user, but if and when it exits the Euro and adopts the Drachma as a currency issuer we will get a true view of Greece’s national production and its ability to support its welfare state and the value of its currency. The outcome will not be pretty.
Your idea that German and Asian workers are beasts of burden by nature and culture for the benefit of privileged Greek and American consumers in an eternal sectoral imbalance is both laughable and inexcusably ethnocentric. The Germans aren’t buying it; the Chinese have no choice but to continue, but their day to turn the tables on spoiled Americans will come.
JWG…I actually agree with the state of the public sector employee and their inflated benefits. Unlike the private sector middle class whose pension funds were raped by corrupt corporate executives once the consultants revealed how it could be done, the public sector benefits will be reduced either by voluntary reducing their benefits or by bankruptcy.
Unfortunately the public sector is so damaged by the the misallocation of money there is no economic theory which provides a magic bullet.
Concerning my lack of statistics to provide those who either lack the ability to remember or were to young to have been consciously observing the economies of the world through the 1990′s there is the internet. This blog provides enough evidence and if not perhaps you should tap the wealth of information provided by the any number of Federal Reserve statistical department or review an interest rate chart of any nation.
Democracies are fragmenting and free markets are failing. I believe it is due to the the free market “engineers” who use congress and the president to manufacture the laws in which these engineers construct their free market.
Please tell me where a free market exists? Perhaps you can tell me the reason why conservatives complain of transfer payments but have no issue with allowing the Federal Reserve and US Treasury to step into the ‘free markets’ when the S&P is at 660? Why the Chinese government supplies massive amounts of support to their industrial base ie solar or why America permits the undercutting of our trade status, shipping jobs overseas, firing workers, promoting the use of debt by Americans?
We are experiencing deflation because the major economies around the globe drown in debt. You destroy debt you destroy savings ie someones wealth so the deflation continues and will not stop until countries become desperate enough to print money in an attempt to save themselves. Inflation is first and foremost a matter of the mind.
FOFOA debunks the MMT boys nicely, putting them aside as a bunch of arrogant ‘we know best and the rest is dumb’:
http://fofoa.blogspot.com/2011/11/moneyness.html
Instead of worshipping digital computer entries & paper+ink it is time to come back to reality again.
The ECB is just a weapon of blackmail in the hands of the Franco-German new alliance to dominate Europe. The French played that game back in WWII and they did not resist. They had one of the best armies but they did not fire a single shot. They should have been divided and punished with the Yalta agreement but for some reason they escaped and they pretend to be democratic when they are only a humble servant of German neo-Nazism.
Only three nations fought in Europe against the Germans, the English, the Greeks and partly the Yugoslavians. The Greek contribution in delaying the German invasion of Russia played a decisive role in their defeat in the heavy winter they faced. This is a crash history course for those that are not aware of the historical facts.
Now you know what happened when Germany regained power: They attacked Yugoslavia and bombed it and they drove Greece to default. All the other nations in Europe, including Turkey were in some way Nazi allies. Turkey was supplying most of the metals the Nazis used to make tank armor and airplanes.
The Italians are getting punished now for their early withdraw from WWII in support of the Nazis.
Whoever thinks that something fundamental has changed since WWII in the way that the Germans perceive other notions in Europe they are dreaming.
The ECB has printed billions to rescue Belgian, German and other banks and corporations. They do that selectively. They bailed out the Belgian bank overnight with 800 billion worth of purchases. The decision took a few hours. However, in the case of Greece and Italy they are negotiating for months because they first want to enforce austerity and make their citizens poor and hopeless so that they can control them with small injections of money.
They (Franco-German alliance) have started imposing political decisions for who is going to be the ruler in a country. They started with Greece where they imposed a man they wanted for PM.
The funny thing is that the French President is of Jewish descend, he was born in Thessalonica, Greece, but does not seem to know or remember what Germans did to the Greek Jews there.
Now, Mr. Roche, what does all theses what to do with the good economics you know and apply only to the US system?
That is a very long peace written Theo. I don’t have the time to read all that today. What these Austrian gold bugs seem to miss is that fundamentally only human work creates economical value. So there is no reason not to create this value.There is no reason to save our human resources and have them sit idle. Money draws It’s value from this work too.
I may be mistaken, but I do not think you have mentioned the name of Alain Parguez as one of the economists whose papers endorse some if not all of the ideas of MMT. Maybe because he is European and teaches in France, so he is perhaps not really in MMT “territory”. Anyway, in some of his papers he does credit Mosler and Wray (amongst other economists who also have MMT inclinations). You can see a list of his papers here http://www.neties.com/presentation%20ap.html
The reason I mention him here is that if you want to undestand better the way ECB functions really operationally and also if you want to get a feeling of how difficult it is for the ECB really to do what everyone is asking them to do (print), you may want to read pages 14-19 of his paper “For Whom Tolls the Monetary Union: The three lessons of the European Monetary Union” (the whole paper is on a different topic but those pages are the relevant ones).
I was under the impression that the ECB by law has limits on buying foreign debt, and a number of its German members have left in protest. How long can the ECB continue to credibly ignore its own mandates and ignore its own rules? Does this put a limit on its long term credibly in terms of stabilizing the Italian bond market. kitchenhelper.
The Eurozone is going to unravel and create chaos. I just wish they would get on with it so the price gold and silver can go up and make me happy. Its as obvious as the blind man who picked up his chisel and saw……