Europe – A Policy Proposal with Teeth?

The big news in the last 24 hours was of course out of Europe.  And it’s finally something that might be credible.  And by credible I mean it might actually be close to a long-term solution.   The rumor is that the ECB might target interest rates specifically (Bloomberg reports):

“The European Central Bank is considering setting limits on yields of euro area sovereign debt by pledging unlimited bond purchases, Germany’s Spiegel magazine reported without saying where it obtained the information.

The policy will be decided at the September meeting of the ECB’s governing council, Spiegel said. The Frankfurt-based central bank would immediately publish bond purchases after making them, the magazine added. An ECB official declined to comment on the article.

Speculation about additional ECB intervention to counter Europe’s sovereign debt crisis helped lift Spanish government bonds for the first week this month. Spain’s 10-year yield slid 46 basis points, or 0.46 percentage point, to 6.44 percent last week, the lowest since July 5.

ECB President Mario Draghi said on Aug. 2 that the central bank may buy government debt in unison with the region’s bailout funds to address elevated yields that are “related to fears of the reversibility of the euro.” Chancellor Angela Merkel backed the ECB’s insistence on conditions for helping reduce borrowing costs on Aug. 16, saying Germany is “in line” with the central bank’s approach to defending the euro.”

This is simple.  If the ECB sets rate caps on long-term rates then the solvency crisis is essentially over.  This would essentially be a pseudo guarantee of bond markets with the ECB’s backing.  This would almost certainly bring private investors back to these markets and help fund the governments.  So we eliminate the solvency crisis.  That’s a HUGE first step.

But that doesn’t fix the Euro for good.  The Euro still needs an entity such as a Treasury to allocate funding to nations as we have in the USA.  It’s not enough to set rate caps because rate caps will almost certainly come with austerity.  In the USA, it’s like setting balanced budget amendments, but failing to spend into the state system at all.  If the USA had done that in 2008 the states would have had massive budget problems (as previously shown).

The bottom line – if this is true it’s a good first step towards fixing the Euro.  But it’s only that.  A first step.  There is more work to be done.