Eichengreen on the Euro Crisis Post author By Philip Lane Post date August 3, 2011 Barry Eichengreen explains why the July deal was incomplete in this article. He explains why the euro is here to stay in this article. Categories In Uncategorized 81 Comments on Eichengreen on the Euro Crisis ← Sinn: Germany’s capital exports under the euro → Shouldering the Burden of our Debt 81 replies on “Eichengreen on the Euro Crisis” Good articles, as usual from BE. But he does seem unduly attached to the idea that if a policy is disastrous it will surely be abandoned. An intelligent man, he fails to appreciate how stupid people can be. Nick Rowe is also worth reading: http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/08/the-monetary-policy-of-last-resort-currency-reform.html Moralistic nonsense. This is not a fiscal crisis even for Greece – this is a leverage crisis. Northern European citizens may be more socialistic but because of this the banks that grew around such apparent stability have grown very unstable – having their way every time. “the worlds oldest democracy” maybe but it had a military dictatorship in the early 70s………. The ECB simply has to produce and give money to Goverment to write down the debt. To be fair it can give money on a European per capita basis – then Germans can holiday in Greece spending money. If the ECB does not produce money and expects people to remain debt slaves then it truely is time to break free from this nuthouse. Double the ECBs balance sheet and lets see what happens – 4 trillion euros is a lot of money even by todays standards. The deal was incomplete because Greece did not default on its Debt. Until such time as European states see that it is fit and proper to default on debts they cannot pay, the entire continent will be racked by crisis upon crisis, with fix after fix, until at least the Bundesbank itself goes bankrupt and all the German savings go with it. It is becoming tedious to read these unimaginative, orthodox, “god fearing” economic policy recommendations. Each advises austerity, inaction and indolence in support of the status quo, warning of catastrophe if any decisive measures are taken. A few months or even weeks after governments follow such advice, the situation deteriorates further. We are in a crisis situation. We need radical solutions. Maybe not too radical, but we’ve got to stop pretending that the application of half hearted textbook responses is going to make everything better again. @Obsessivemathsfreak I sense a inner conservative trying to break out “maybe not too radical “……….. Off-topic, but I get frustrated every time someone pulls some ancient Greek factoids/wisdom in discussing our contemporary Greece; it’s twice, thrice, quadrice, quince as far-fetched as to invoke Arab culture in describing today’s Spain. If they want to go historical, try Byzantine/Ottoman instead at the very least. The ancient Greek “genes” disappeared from that land centuries ago. Sorry, folks, carry on. Dork, when I say “too radical”, I mean October Revolution, Storming the Bastille, Cultural revolution type radical. I mean default on all debt, new currency, mass bank/financial institution nationalisation, and an end to the free movement of credit. I don’t think we need to go that far yet. When I say simply “radical”, I mean simply that an end is called to the dictatorship of the markets. I mean extensive structured defaults/ debt-equity swaps, banks allowed to fail, tighter regulation of credit and stock trading, quantitative easing and government capital projects where neccessary, and higher income taxes for the underspending wealthy (>90%). By simply “radical”, I mean the use of state power to forcefully redistribute the current imbalances of wealth in society. I do think we need to go this far. I’m sure the minds of “god-fearing” economists recoil in horror at such suggestions. To those I say, propose an alternative strategy that will actually work, because your current ones don’t. @obsessivemaths freak Fair enough – but my solution is quite simple really ,which could be characterised as being both extremely radical or conservative in this strange mixed up world. Destroy leverage. The banks can remain in the debt business if they buy Gold up to M1 or beyond(M2 maybe even M3) or we can just go back to full reserve banks – this will change who is in charge but not the dynamics to some extent. This leverage on top of leverage with the buying of even sov debt & paper Gold with credit must stop if you want this capital destruction yield seeking madness to stop. It does not produce any wealth so therefore its destruction will not destroy wealth , it will free up resourses to build rather then extract wealth. However don’t hold your breath – the west is in terminal decline , we are in Romes later stages now , there might be 50 more years left in this baby but more then likely this ship is going down much sooner. Practically no American academic ,even brilliant minds like Krugman ,understand anything about the European construction(this is even worse among journalists).This is not surprising :it is such a convoluted contraption with such an unlikely history that it takes a lot of effort to make any sense of it. Mr. Eichengreen is no exception. I find Mr. Buiter paper much more thought provoking although it is poorly written. @Overseas commentator The Euro construction is a extremely strange banked creation for sure – if they want to preserve this present contraption they need to produce cash pushing up the price of Gold to unheard of levels. Example : ECB subtracts peripheral euro sov debt , converting it into euro cash to fund goverment , thus exploding the Euro balance sheet – turning commercial banks in the periphery to all Goverment saving vehicles as we hopefully save the cash to “fund” goverment. If we “save” this cash by funding goverment there should be no inflation but watch the defecits go past 200% & property reach its true value. More traditional single sov / bank systems could just go to full reserve banks. The reasons he quotes to support his notion of irreversibility of Euro project are IMHO technical and rather trivial. The Euro is being kept together not because there is democracy in Greece or because Greeks can’t reprogramme their computors but because the core Eurozone continues to support the project. This is because the bill so far is manageable. Let’s see what happens when Spain and Italy come under the spotlight and when the bailout requirements multiply. So far, the problem is not fixed. It has been swept under the carpet. @ Overseas commentator You are absolutely correct. The second paper by Eichengreen on the consequences of leaving the euro is spot-on. The first completely misses the mark because he grasps neither the politics nor the institutional structure of the EU, particularly in relation to the role of the ECB. @ Fulcrum You have a point. But as Eichengreen obviously views the ECB as ‘deus ex machina’, an explanation – with your permission – of the term (courtesy of Wikipedia) seems in order. “The Latin phrase deus ex machina comes to English usage from Horace’s Ars Poetica, where he instructs poets that they must never resort to a god from the machine to solve their plots. He refers to the conventions of Greek tragedy, where a crane (mekhane) was used to lower actors playing gods onto the stage. The machine referred to in the phrase could be either the crane employed in the task, a calque from the Greek “god from the machine” (“ἀπὸ μηχανῆς θεός,” apò mēkhanḗs theós), or the riser that brought a god up from a trap door. Although this phrase is somewhat diluted in transliteration as earlier in history, the phrase “god from the machine” implies the old use of mechanical manipulation, i.e. to be made with one’s hands. So if there were a more generally accurate way of translating deus ex machina into English, it would be “god from our hands” or “god that we make”, implying that the device of said god is entirely artificial or conceived by man”. Poor old Trichet must avoid falling through a trapdoor tomorrow rather emerging on stage through one. I think both papers by Eichengreen are very good papers. His first paper analysis is spot on. The whole dog and pony show has been about protecting large European banks, particularly French banks. His dismissal of the sheer obstructiveness of the ECB to a workable solution, is something that Ireland has experienced first hand. The conclusion of second paper, ie that the euro will survive, is given a high probability rating but per Eichengreen, it is no longer a certain bet. He is probably corrrect that German business interests will rule with their heads as against the more rabid and nationalistic voices. He may be right. He has highlighted one issue in particular. He says we need the cooperation of the ECB to make a proper bailout to work and to make the euro survive. What an insightful statement on the extraordinary position of the ECB. But given the sheer malevolent moralising obstructionism of the ECB, I would not be hopeful of any cooperation from that so called independent institution. The ECB has thrown its lot in on the side of the large banks, particularly French banks. Regulatory capture, par extraordinaire. The fact that the head of the ECB speaks French fluently does the case of the French banks no harm at all. @ All The Telegraph reporting that ECB to announce its back in the bond buying business tomorrow, to bridge the gap until the EFSF 2.0 is fully up and running. Probably the last throw of the dice. @Joseph Ryan Perhaps having a man with experience from inside the Lire is the logical next step for the euro… @Bond. That will make interesting trading tomorrow. The ECB buying Italian bonds like there was no tomorrow and Duetsche Bank selling Italian bonds like there was no Italy. Sure the money need never leave Frankfurt. One could always ask Herr Prof Sinn to give us his ‘buy a tractor’ analogy of the effect of the days trading on the Target2 balances. ECB buying bonds? If that is to work then the confidence-fairy need to make an appearance… @all May one assume that someone has maintained the printing presses in Frankfurt? Hopefully someone will remember how to use them? Toss us at least fifty billion in vichy-banking debt while you’re at it … and we’ll figure out the rest of it. @Bond Eoin Bond Interesting bit from that article… “However, Italy, with a debt equivalent to 120pc of GDP, is on an unsustainable path and “bound to default” on its obligations, while Spain is better placed but may still get dragged down in the turmoil, according to forecasts from the Centre for Economics and Business Research. The think-tank is now “pessimistic” about the euro’s survival. If one country defaults other euro members will face higher borrowing costs, making devaluing their currency by leaving the monetary union more attractive, it said.” But then the Telegraph is a well known Euro sceptic. Are these chaps credible? @Joseph If Ackermann hasn’t unloaded them already then he is daft or incompetent. It has been well flagged who was next in the firing line. From BE’s 2nd article – “German business also understands that a move to reintroduce the euro would create massive financial crises in other European countries, as individuals there shifted their bank deposits en masse to Frankfurt”. Typo, surely, on “reintroduce”? Re the ECB and bond buying – if I’d a Norwegian Krone for every time they’ve supposed to HAVE been in, and they weren’t, I’d be rich. This “will” be in is a new one on me though. Largely off-topic. A friend passed this on. Dr Gilliam Tett, “Silence and Silos: The Problems of Fractured Thought in Finance” during an inno-vent session at the 109th Annual Meeting of the American Anthropological Association. Picks up on many thoughts expressed by contributors here, particularly, I would say, the Dork and paul quigley. @ aiman From the first article: “And the ECB, having now totally wound down its program of bond market purchases, shows little inclination to step into the breach.” Do you think the ECB has never been bond-buying as this assumes? Or is it that you’re saying they’ve done it far less than supposed. @ all “Only the ECB can halt eurozone contagion” FT Opinion piece by Paul de Grauwe http://www.ft.com/intl/cms/s/0/4fd2a0c8-be10-11e0-ab9f-00144feabdc0.html#axzz1U1ogQJUM @Bond Eoin Bond “Probably the last throw of the dice.” Before…what happens? Should make for an interesting couple of days. Hopefully, I’m going to be glad I swapped my meagre savings into £’s back when it was near parity with the Euro! If I hear anymore from Trichet about curbing inflation by raising rates today I will scream – interest rate rises only stop consumer inflation, transferring wealth. Since CBs have come into existence they have watched over banks that have increased credit aggreagtes over and above population growth – thats inflation baby. The ECB more then any other CB concentrates on wage deflation so that its monstrous credit growth is directed towards its friends and we get 2% consumer inflation. Its the sickest institution on the planet. Lying & lying….. & lying ……….and getting away with it… its amazing really. @ Gavin ECB publishes details on its bond buying program every Monday. Its flat (actually decreasing slightly due to some maturities) since January. If the ECB is buying bonds it certainly isn’t paying over the odds. Hmmm, Trichet teasing the market a bit, “never said bond buying program was dormant, or interupted”, “bond program is ongoing “, “you will see what we do”. Sounds like they’re not hitting the trigger yet, but that they’re there if they feel they need to. Quite why he doesn’t think we’re there yet is the problem… Scratch that. Looks like they’re in buying. Over the years the view has been that bonds from first world countries were safe, boring and of low yield. Yet a country is about the most complex economic entity that there is, vastly more complex than say most larhe public companies. The analysis of a complex country’s health is actually very tough. And now with freer trade and globalisation, countries are much more exposed and volatile. I don’t think anyone knows how to price them, and overall I think the safest strategy is to keep state/fiscal spending to a low proportion of overall GDP, as that offers the most headroom/buffer. Also Europe, now looking more fiscally integrated, needs to get more economic efficiency. So if there’s a lot of unemployed Spaniards…and Germany is paying…well maybe those jobseekers should be required to look in Germany. Overall as such, I see the trend as tending towards smaller state sectors, and much less governmental economic influence. I’m not sure what say the French might think of that….also I’m not sure enough on this overall trend to be certain…but it looks likely to me. Eoin, is it true that they are buying short dated Ireland and Portugal but not Spain or Italy and in small amounts to boot? If true, they should not be allowed out alone…not safe. Barroso assures us that he (and his Commission colleagues) ‘stand ready’. Brussels, 3rd August 2011 Dear Colleagues, Developments in the sovereign bond markets of Italy, Spain and other euro area Member States are a cause of deep concern. Though these developments are clearly unwarranted on the basis of economic and budgetary fundamentals and the recent efforts of these Member States, they reflect a growing scepticism among investors about the systemic capacity of the euro area to respond to the evolving crisis. Markets remain to be convinced that we are taking the appropriate steps to resolve the crisis. The 21st of July bold decisions on the Greek package and the increased flexibility of the EFSF (precautionary use, recapitalisation of banks and intervention in secondary bond markets), are not having their intended effect on the markets. Markets highlight, among other reasons, the global economic uncertainties due to both economic growth and the protracted decision on budgetary adjustments in the US but, first and foremost, the undisciplined communication and the complexity and incompleteness of the 21st July package. Whatever the factors behind the lack of success, it is clear that we are no longer managing a crisis just in the euro-area periphery. Euro-area financial stability must be safeguarded, with all EU institutions playing their part with the full backing of euro area Member States. We need also to consider how to further improve the effectiveness of both the EFSF and the ESM in order to address the current contagion. Concretely, I would like to call on you to accelerate the approval procedures for the implementation of these decisions so as to make the EFSF enhancements operational very soon. These changes should also avoid introducing excessive constraints in terms of either additional conditionality or collateralisation of EFSF lending. I trust that governments and national Parliaments will rapidly approve these decisions necessary to improve the EFSF flexibility. I also take the opportunity to urge a rapid re-assessment of all elements related to the EFSF, and concomitantly the ESM, in order to ensure that they are equipped with the means for dealing with contagious risk. Finally the Commission stands ready to contribute to the improvement of working methods and crisis management in the euro area. Yours faithfully, José Manuel BARROSO @ Tull correct. Its a joke. Meltdown out there. I can finally understand how the Great Depression of the 30’s happened when central bankers kept making policy mistake after policy mistake. We’re really close to a new Lehman’s style collapse here. @tull Talk is they couldn’t get the Germans to agree – and where is the political cover anyway. The Spanish government are spinning a line that bond yields going up is just a summer vacation thing, the Italians have Berlusconi telling people higher bong yields only affect a small amount of debt and his government saying the are “fully funded” for months and don’t need to access the market – but that wouldn’t mean they couldn’t if they wanted to. Italian authorities raiding the offices of rating agencies. Unicredit anyone..? Trichet tells everyone to have a look next week if they are interested in EBC bond buying. You couldn’t make it up. @Bond Eoin Bond You usually don’t scare the horses but you are making me nervous. What is a safe haven now. Gold anyone @1664.7 Gold has no inherent value, and is of limited worth. The Swiss Franc is suffering as people are flocking to it. China has a property bubble…the US dollar is a deeply weird currency (as so many others peg to it) I’d say right now the safest haven is a company with solid fundamentals (earnings, people , products, assets) , and a modest pile of cash on the balance sheet….enough cash to avoid a crunch…just not too much as cash is in some currency 😉 @ All It is interesting to note that the entire European debate can now be reduced to two questions (i) what will Germany agree to and (ii) how soon? For the moment, the answer from the German voices within the ECB and from Merkel (walking in the Dolomites) is nothing. Barroso is stating openly what by now is evident; the approach dictated by Berlin since the start of the crisis has collapsed. “These changes should also avoid introducing excessive constraints in terms of either additional conditionality or collateralisation of EFSF lending. I trust that governments and national Parliaments will rapidly approve these decisions necessary to improve the EFSF flexibility. I also take the opportunity to urge a rapid re-assessment of all elements related to the EFSF, and concomitantly the ESM, in order to ensure that they are equipped with the means for dealing with contagious risk”. I would suggest that the answer to the question may be foreshadowed by developments (i) in the global economy as reflected in the DAX, closing off an imagined safety net for the German economy (ii) within the ruling coalition – a member of the CDU having told the press in the past few days that “its difficulty is the FDP” – and (iii) Franco-German relations, especially with regard to the governance guarantees that Germany sees as a sine qua non to overcome the moral hazard risk i.e. of pouring money down a black Mediterranean hole for no return. It should also be clear by now that this is an existential political problem confronting the Eurozone and it is for its political leaders to solve, not a central banker, however talented or untalented, according to the view one takes. (It would take a really untalented official to tell the markets beforehand what his/her bank intended to do in those markets). Look the good news today from ECB/Trichet press conference dealt specifically with the Irish macrobalance. Trichet said with conviction that , so far, Ireland is on right track from its policy implementation. Of course, the road ahead is not going to be a straight line; yet compared to Greece and Portugal, it seems Ireland is pulling its weight. SO the politicians must be doing something right. Eichengren is not an ideologue. He’s literally the most conversant student of what happend at Maastricht and why. The Geman CB didn’t believe in euro replacing DM (Tietmeir). Chancellor Khol bullied the GCB to go with euro because it was a civilization development – after centuries of inter-state wars! The interesting part of this ‘crisis’ is that while the ‘market’ is crying for urgent action (bail me out now, bail me out now) the ‘crisis’ is not materialising even though the bail out is not happening. Some bondholders are in a bit of a bind, if they don’t support the countries at risk then they themselves will fall. Some banks have no other option than to continue support Italy and Greece or they’ll themselves become insolvent. Maybe the confidence fairy will appear after some ECB bond-purchases and then the confidence in the periphery’s ability to repay will be restored 😉 Or lets hope that democracy and law stand up against the financial industry and let the financial industry get the return of investment their (in)competence warrant 🙂 @Desmond As long as we have a debt based currency Gold becomes a accounting metal on CB balance sheets – it is because it is a nearly useless but relatively rare metal it is kept on the books. The dollar however is showing signs it is reverting back to its Greenback roots (QE2 is synthetic greenbacks as interest is returned to the US treasuary reversing 30 years of major capital extraction through usurious rates under Volcker and his descendants) Its been Gold bitches vs Dollar bitches and it seems always will be. @DOCM “It is interesting to note that the entire European debate can now be reduced to two questions (i) what will Germany agree to and (ii) how soon.” Prof. Buiter put it succintly today by saying in essence that the ECB can chose between large scale bond buybacks and several avoidable defults plus the worst banking crising since 1931. To which you could add the end of the euro, the largely W. European project and a Great Depression to boot. There is plenty of blame to go around & the ECB may not be the worst actor in the plot. As you might put it yourself, the Germans and their allies have now to choose between a fiscal transfer to the south or the loss of their export markets. I doubt whether an Italian govt will hang around in a single currency that imposes debt deflation on its populace. @ tullmcadoo I do not think that this decision is a fair burden to place on the shoulders of a group of European public servants. I have said it before and I will say it again: economists, however eminent (and I would not include Buiter in that category), have a tin ear for politics. The distinctive characteristic of the ECB is that Germany does not have a proxy veto in its decision-making procedures. If she did, I frankly do not know whether we would be better or worse off. Given the track record of recent German governments, I tend towards the latter opinion. The US was for a period a state without a central bank (until 1913), the ECB is a central bank without a state. There is no sign of the latter on the horizon. This means that the sovereign states involved have to come together to provide the necessary credibility to overcome this handicap. This will require a system of checks and balances which, if Sarkozy has any sense, which I doubt, he will agree with Merkel before the end of August (as he has, incidentally, promised to do). In the present circumstances, where the investment community is like the elephant that ran off in all directions, I happen to agree, for once, with the phlegm and insouciance being demonstrated by Merkel. @ CP I had an epiphany this week, that basically the ECB is the only thing that can bridge the gap and keep the wheels turning until the EFSF is up and running (yeah i know, large ‘if’ there too, and question marks over whether the EFSF can solve anything, but at least it has a chance). The ECB, on today’s form at least, has failed miserably in that task as a result of their own decision making (again, i accept that this may not be purely the ECB’s problem to fight, and the EU pols have been just as bad at times, but the ECB has a lot more leeway to instantly react, and standing back and doing nothing is not a responsible action either). For Trichet to claim today that the ECB “hadn’t ruled out a rate hike” is both surreal and sickening. The Euro is facing an existential crisis, maybe even a collapse, and he’s worried about 2.5% inflation and the ECB’s “credibility”? Memo to JCT – you no longer have any credibility sir. Act now or do the honourable thing and go. 350 million people are relying on you. Well said Mr Bond. Can other countries also use the promissory note tactic used by Ireland? Would enable some governmens to get banks on the cheap (as long as the banks taken over wouldn’t be run as Anglo). @Jesper “Would enable some governmens to get banks on the cheap (as long as the banks taken over wouldn’t be run as Anglo).” “wouldn’t” isn’t the problem, it is “weren’t” in the case of Anglo and I suspect in the case of some other banks that have mountains of bad debt recognised on the books as molehills. Won’t somebody send a miracle to those poor bankers? @hoganmahew, you’re right. If there are some mountains of bad debt (banks that operated in FIRE economies are likely candidates) then there will be problems. I’m not a big fan of ‘extend and pretend’ so it would be distasteful to do so towards their ‘normal’ bad debts to get by the possible problem of bad debts resulting on holding sovereign debt. Still, I believe using equity to soften the blow to the sovereign might help some. Supposing the banks are basically sound then a sale of the banks after clean up might give a good return. The below shows some of the proceeds Sweden managed to get after taking equity in return for aid: http://www.businessweek.com/news/2011-02-04/sweden-sells-3-billion-nordea-stake-to-reduce-debt.html It was a different situation, still I do think that as equity is risk capital it should carry some risk for the owners. The ones taking the risk should get the return. Owner can recap their banks or risk losing them now. Banks used to like taking over an illiquid but solvent business on the cheap. Turnabout should be fair play. The current funding model of the EFSF doesn’t scale to cover Italy and Spain, so the ECB are the only ones that can provide the funds for these countries, however they are going to want lots of guarantees, warranties, indemnities etc. so that the EFSF/EU-taxpayers will be on the hook to pay all the money back (and prevent inflation/monetization of the debt). Now that the PSI battle is over (banks get a slap on the wrists; politicians get a few laudatory headlines; Greece gets more debt) the new battle lines are between Euro currency holders (supported by the ECB) and the EFSF/EU-taxpayers. The ECB already has a guarantee regarding Greek collateral although it seems as if there was a deliberate attempt to keep this news quiet “because of concerns about the reactions of the financial markets”. I imagine that in practice there are lots of ways that these indemnities can be provided. One is through the mechanism suggested by hoganmahew a few days ago – which in effect means that the ECB repo market can be used by the EFSF for infinite leverage. (In this scheme the EFSF buys bonds, repos them, buys more bonds with the proceeds, repos them etc.). Presumably the ECB could agree to this scheme if suitable indemnities are provided, and has the ongoing threats of margin calls or failing to rollover the repurchases when they expire, to force performance by the EFSF. The ECB won’t want to take much more debt into its existing SMP scheme until the new guarantee schemes are in place. However given that the top priority right now for most EU leaders seems to be to take vacations as planned, it is possible that they will be overtaken by events. Germany is deliberately slow-rolling the process, since it will be the main provider of all the guarantees. In a crunch though Germany gains far too much from the Euro to see it fail, so right before the point of collapse the guarantees will be provided, and the ECB will provide the funds. @ Bryan G FYI http://online.wsj.com/article/SB10001424053111903454504576488380933726372.html?mod=googlenews_wsj The WSJ evidently believes in shooting a few ECB foot soldiers at dawn because of the failings of Europe’s generals. Their journalists are, as they invariably do, confusing Brussels with Washington. The calamitous late slide in the DAX appears to have finally woken up German investors to the realities of the situation. Merkel may have to come back from her holidays. @ Bryan G Inserting the full title of the article in Google search should get round the WSJ pay barrier. The Telegraph cheerily wades in: “The ECB throws Italy and Spain to the wolves” “The European Central Bank has abandoned Italy and Spain to their tortured fate.” “Mr Trichet said the ECB’s governing council was divided over bond purchases but gave no further details.” http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/8682852/The-ECB-throws-Italy-and-Spain-to-the-wolves.html @E Bond actually…the best gap pluggers would be TheFed …they could claim it was only for liquidity, and do a spot of the old q/e . And with the USD’s uniquely odd status…it could absorb the hit…indeed given the current demand for the dollar, it might even be wise. Or the IMF could get into the shenanigans…and have the relevant countries print the SDR’s… @Bond Eoin Bond Your earlier post was remarkably prescient….meltdown. It is looking like that this evening with the Dow off 512 points. I gather from the post by DOCM above that the DAX also had a late slide..I think it is off about 9% in less than a week. You are right… It is incredible that the ECB did not hit the markets hard in the case of Italy and Spain ensuring their yields dropped this afternoon. What was the point in buying Irish and others when the damage is already done to their market credibility. But Italy and Spain are a different ball game and they could easily bring the whole house down. Surely the ECB have the fire power to rein in ITalian and Spanish yields. The only reason I can think of for not acting decisively is the dissent by the Bundesbank boss and apparently some other members of the governing council. Perhaps limits were set for Trichet. @Bond. Eoin Bond +1 I fully share the analysis of Paul De Grauwe. And you what? If the ECB continues to refuse to act as lender of resort to its multiple sovereigns, my real fear is not that the Euro will collapse, but that it will not collapse. We are really not far from a totally avoidable financial meltdown of the whole Euro Area. @Gavin I had not seen the Telegraph article when I posted above… “Jean-Claude Trichet, the ECB’s president, said the bank had purchased eurozone bonds for the first time since March but this token gesture was confined to Ireland and Portugal, countries that have already been rescued. Professor Willem Buiter, Citigroup’s chief economist, said the apparent ECB action was pointless. “The warped logic of intervening in two countries that don’t need it is as strange as it gets.” Strange indeed. Lads, we are being too hard on the ECB. They tapped on the monetary brakes, got commodity prices down, cooled the Eurozone economy and brought inflation back to target. They also ensured no bank in the EZ failed- bar one. Moreover, they have put in place an early version of a fiscal edifice in Europe. I would JCT can shuffle off into retirement , safe in the knowledge that he has done the state some service. The job should be oxo for M. Draghi. @Gavin – superseded by events (and Eoin Bond’s news plus explanation of reporting procedures) but the market/media reporting of ECB intervention since its commencement in the middle of last year have been shown to be a lazy way of explaining any downward yield move in peripherals or, on a less savoury note, an attempt to scare peripheral bond prices higher, with a view to selling. The size of the buying is known, at €76bn up to last week. The current value of the stock purchased isn’t. Rough estimates – and they can only be rough as no detail is available of either the markets or maturity areas purchased – put the loss to date to the ECB at anything from €10bn to €15bn. If as reported the ECB were in today, it calls to mind the old saying as Gaeilge “Is beag rud nach cuidiú, arsa an spideog agus é ag sileadh leis sa bhfarraige mhór”. @Tull You are being kind to the ECB: Could I suggest Cromwell’s exhortation to parliament (albeit with a little support from his roundheads) ‘You have sat too long for any good you have been doing lately … Depart, I say; and let us have done with you. In the name of God, go!’ The usual suspects need to divorce themselves from old sovergin money thinking. The ECB wants credit deposits buying Gold – this will enlarge its balance sheet at the expense of sovergin goverments on a relative basis. I think its crazy but…………… If it supplied cash to “sovereigns” it would give power to executives on a equal basis – but it wants to crush whats left of the nation state both inside & out of the union. These puritans are staring yee in the face. The proof is in the pudding. This could get quite dramatic but goverments are full of weak sycophants – The Euro central banks will most likely win this battle – they have been preparing for decades. Looking at the general market carnage…it is clear that we are at is discrimen. The worry in the stock markets is about general PIIGS mess, not just the bonds that happen to be in the secondary market. The ECB using its scarce real money to mop up what’s in the secondary markets…will achieve nothing. The uncertainty needs to be ringfenced, the debt needs to be temporarily monetized. The ECB should swoop and buy 20-60% of ALL the debt in issue of ALL Euro countries. This debt should be redenominated as ‘super junior’. The purchases should be funded by money printing. The back end money could be Eur…or as a better stopgap Usd(from The Fed). A new fiscal agency should manage both sides of this debt. Anything else…leaves hopeless toxicity of uncertainty in the system. Non-farm payrolls tomorrow – oh, and you can still argue this applies http://www.irisheconomy.ie/index.php/2011/07/17/sunday-night-open-thread#comment-157452 @DOCM Also there’s some more commentary here that ends with the question “Does Germany accept the monetization of foreign bonds at German taxpayer expense or does Germany leave the Euro?” Since a New Deutsche Mark would end up like the current Swiss Franc I cannot see Germany leaving the Euro. Their whole economic model is based on high-value hard-to-replicate exports which benefit greatly from a reputed 30%-40% difference in current Euro value vs a New DM. This amounts to a massive export subsidy. There are going to be some trigger points between now and when the newly reconstituted EFSF is fully up and running, e.g. either a 7% yield or 4.5% spread for Italy. There could be some real chaos when this happens, since the entire EU decision-making apparatus cannot operate in real-time. @Bryan G The trigger point may be Spain canceling the next scheduled bond auction…as reported by RTE. Won’t go down well in markets am…expect more chaos. @grumpy The employment data could trigger another massive selloff. They are expecting 85,000 which is clearly not enough. Another ominous sign is BNY Mellon charging 13 basis points for minding all the excess deposits building up. What’s that Chinese curse…. I don’t think the Euro can do QE in the sovergin money fashion. What is QE ? Its the excess reserves in the system that cannot or will not be lent out. It recapitalises the domestic treasuary via interest payments and so takes money from the private sector. Its the very opposite of the great run in Treasuries from 1980 – 2008 when interest / wealth was extracted from the economy to fuel consumption. So if the Euro cannot do QE as it has no sovergin what can it do ? It can provide cash to goverments replacing interest bearing bonds. But if it expands its balance sheet it will drive Gold prices higher – this will recaptilise the CB system but in a different fashion from QE. This is getting interesting. @CeterisP The trigger is now…a 512 point Dow drop is a crippling spillover into the real economy…all of PIIGS debt in issue now is toxic…all connected banks and holders are toxic. This is an unprecedented shock to global financial stability…and the Euro area has been babbling a nonsensical cacophony for months now…the horses are bolting, and soothing words about future plans won’t calm them. Sharp action is needed now, else the whole global real economy will crunch. The only options now is to rapidly ringfence the problem,and I don’t think an orderly default is even possible… @ceteris The BNY thing points to something you might want to wlook out for. Hedge fund redemptions. If they start adding up sufficiently all sorts of financial assets – even potentially gold – could get sold off. @Desmond It’s hitting the fan all right. RBS taking an 840m hit on GReek sovereign (reported by Sky reporter and repeated by Reuters) They reported a direct exposure to Greek sovereign debt of 1.16b in July. Now that looks like some haircut. Listen gentlemen – 5000 to 10000 a ounce and this false crisis is all over , unless the ECB really wants to push goverments into the ground that would be counterproductive to its interests. Its playing with them as a cat plays with a ball of wool. Goverments do not have to pay interest , only private debt arrangements should be interest bearing. There’s nothing really wrong with the solvency of Italy for example if new debt is just cash. The entire thing is a sick joke. @Grumpy Gold is selling off. Rumors the hedges are selling gold for cash hence the BNY Mellon move. Suggestions that Paulson is down 20+%. Another victim of leverage. @CeterisP in general Hedge funds leverage….I’m thinking….I can’t see how to leverage pure cash…please tell me they can’t ? @Desmond I think the hedges are selling off anything that they can so as to provide for the inevitable redemptions ( as Grumpy suggested above) look how far oil has dropped for instance. An explanation for the lack of action by the ECB to the Spanish and Italian crisis…. “Yesterday’s response may have been “the best the ECB could do because the Governing Council could not agree on a shock-and- awe response,” said Peter Westaway, chief European economist at Nomura International Plc in London. “If so, this is concerning.” @ceteris Wouldn’t say gold selling off yet – almost at all-time high. Vix is up a decent amount but the futures are clearly in backwardation so only a short term spike is in discounted. Don’t forget, the reason hedgies get sold off is because they are not going to get bailed out if they go under. Well yes they may/will be caught when they have to close positions…but also, pure cash is the safest haven. and right now,moving to it…might be the safest investment strategy. Also the USD has a deeply unnatural/unique position in global monetary terms…and the flight to the dollar is having a massive distorting effect. weirdly/unfairly the US is benefiting from this, but it is going to make balance of payments totally insane, and the real global economy a mess….I can’t begin to see a way out of that one…I know that a move to some form of SDRs/basket as the ‘peg’/global trade/reserve currency makes more sense than ever…but have no clue how that move could be effected @Grumpy Gold looks like it finished in the US at 1643. I looked at it earlier and it was going up to 1673. That is quite a movement. VIX was up 28% earlier. Depends on the Asian markets now…I expect a big selloff. @Desmond Don’t know about pure cash being the safest haven… especially when you have to pay for holding it. The financial press are confused because the ECB helped countries that did not need to be helped now (Ireland and Portugal) and did not help countries that do need to be helped (Italy and Spain). However this is to make the common mistake of solely looking at the crisis through an economic lens. At heart the Euro is a political project, not just an economic one. Looked at through this lens things make more sense – the signal is being sent that only countries that have agreed to surrender sovereignty and submit to centralized EU control of their fiscal budgets will be helped. The ECB are in the vanguard of the EU integrationist/federalist project, and I think they have a very clear picture of what they would like the EU governance structures to look like in the future. The crisis will be used to further these integrationist aims – in fact it is only at moments of crisis that the bigger jumps can be made. That’s why the ECB did little to support Irish bonds after the Merkel-Sarkozy Deauville meeting – by staying on the sidelines they forced the issue of the bailout. They will do the same again now until more steps have been taken by Germany, Spain, Italy etc. towards centralized EU fiscal and economic governance and debt management. As the governance of the ECB becomes dominated by debt ridden countries there will be a sea change in ECB policies. Poor Germany will be wringing its hands on the sidelines as quantitative easing becomes the order of the day. This will be followed by high inflation and within a decade the burden on the PIIGS will have evaporated. The Euro which aspired to be the new Deutsche_Mark will be the new Italian Lira. I am deadly serious about this, it is not possible to bail out Italy and Spain, the collapse of the Euro threatens civilization as we know it. It cannot happen. @Bond Eoin Bond “I had an epiphany this week…..” Excellent post sir and +1 @ All Lot’s going on, but just to note – wowsers! The Italian prosecutors aren’t too happy with the ratings agencies: “Police raid Milan offices of Moody’s and Standard & Poor’s” http://www.guardian.co.uk/world/2011/aug/04/police-raid-milan-moodys-standard-poors Bryan G +1 @ All ECB back in on Portuguese and Irish bonds this morning, but no Italy or Spain as of yet (though both are performing well). Almost seems like they’re slapping the markets and the EU in the face. Reports out that both Bundesbank reps, and 2 others from Benelux, voted against restarting SMP, ie a sizeable minority and most of the effective ‘core’ voted against it. Markets calming down a little bit, but reckon its more a case of people assuming that something big happens in the next few days (co-ordinated intervention?) than any actual stabilisation What is the saying about the size of the loan decides who is in trouble (lender or borrower)? Some Italian and Spanish banks are so heavily exposed to their respective sovereigns that they are now in weak negotiating positions. If those sovereigns asked for a voluntary bond exchange for lower interest longer dated bonds then those banks might have no other option than to agree or risk going under. Some banks might even benefit by going into the secondary market and going ‘all in’ and buying more bonds at a discount and passing on some of the discount to the sovereigns (wishful thinking, I know 🙂 ) Comments are closed.