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IT’S BEEN DARKLY amusing watching European leaders continue to increase the size of their “bazooka” over the past two years, only to see the markets return fire, and render it useless.
First they thought they could solve the problem with a few hundred billion euros. Then they had to double that. Then they had to leverage what they doubled. And now there are calls for even more money.
Not only hasn’t it worked, each time, everything’s just gotten worse.
But there is a solution. The markets seem to think we’re about to see the ECB enter into the fray as a lender of last resort to troubled countries. The ECB already nibbles in the secondary bond market, but at such low volumes, and such random intervals, it doesn’t mean anything.
The solution: The ECB needs to declare an interest rate cap for various countries, and tell the market that if X-country’s bonds hit X-rate it will intervene.
Goldman Sachs made this point this week, drawing on the Swiss example. In Switzerland’s case, it wasn’t about debt, but about the value of the Franc. It tried for a long time to strengthen the euro against the Franc, spending billions to no avail. Then it just came out and said: This is it, we’re going to put a floor under the euro (against the Franc) and that was that.
Here’s Goldman:
The success so far in the SNB strategy indicates that credible commitments backed up with the threat of unlimited action are likely in general to be much more effective, and cheaper, than vaguer intervention strategies. This lesson is one that is familiar from economic theory (a fully credible commitment will not in fact be tested) but the recent Swiss experience is a clean reminder.
The key point: Not only has the strategy been more effective for Switzerland, it’s been cheaper!
Edward Harrison at Credit Writedowns has been making this point for a while now, and does think that ultimately the ECB will monetise Italian debt this way.
Here are his key thoughts on it:
The ECB would ‘guarantee’ a rate for Italian bonds that is high enough to be a penalty spread to Bunds – liquidity at a penalty rate – say 200 bps to German Bunds, which would be 3.8 per cent on 10-year money. The ECB would not necessarily have to buy any BTPs to defend its target. The private sector “would do it” for the ECB via the language and confidence in the “guarantee”. That’s how it works at the short end of the curve with the policy rate by the way and it is also exactly what the Fed did during the 1940s and 1950s; so we know ‘financial repression’ works. After an initial foray in the market to prove the credibility of the backstop and to ‘punish’ speculators, every speculator would blanch at going up against the ECB’s wall of liquidity for fear of insolvency. I added the part about speculators because that’s how policy makers in Europe think about this crisis.
The point is that this is a moral hazard. The only way to credibly force countries within the euro zone to get on board with fiscal tightening is fiscal integration. That’s why a future rump Euro will have it or be comprised of more similar national economies. In the absence of fiscal integration, you have these makeshift policies of moral suasion and empty threats.
In Ireland, Portugal and Greece’s cases, the threats are more real because those economies are small. The ECB would not risk its anti-inflationary credibility to monetise the debt of smaller euro zone countries like Greece, Portugal or Ireland. However, Italy and Spain are too large to believe this threat is credible.
So the ECB is solution is not 100 per cent perfect because of this moral hazard bit, and the fact that it would immediately take the pressure off of Italy to go ahead with reforms. It’s a bit of a chicken and egg thing.
But remember, if the ECB does go in soon, its success will depend on the approach it takes. As Cullen Roche points out, if it just comes in and buys a ton of debt, it will fail and will have spent a lot of money. However, if it says, “we will not let Italian yields rise above 4.5 per cent” then it will succeed on the cheap.
- This article by Joe Weisenthal first appeared on BusinessInsider.com
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We should adopt sterling as our currency, Sterling is more natural choice for Ireland than the €uro as we are economically and culturally closer to Britain than to Europe. Also the sinners should like it as we would have an all Ireland currency
In theory this would be a good move for both countries but I don’t think it will ever happen because of the politics behind a move like this, there would be riots ha
And have the British government control Irish economic policy as well as foreign trade. Why stop there, let’s go all the way and cede power and administration to Westminster…oh yeh, I forgot, we tried that for 800 years and it didn’t work.
Sean
Well we made a mess of things well enough on our own, surely being with Sterling would be better
You need to let go of the past and think of the future
I’m Australian, Ireland’s past is of limited interest to me. I just made a non emotive forensic analysis of the facts and gave an honest opinion. Your argument suggests that Irish people cannot be trusted to be in charge of their own destiny. Maybe the quality of Irish people you meet in Australia is unrepresentative and you may be right, but I don’t think so.
I’m Australian, Ireland’s past is of limited interest to me. I just made a non emotive forensic analysis of the facts and given an honest opinion. Your argument suggests that Irish people cannot be trusted to be in charge of their own destiny. Maybe the quality of Irish people you meet in Australia is unrepresentative and you may be right, but I don’t think so.
Apologies for the double post
@derek.. Riots????? Are you having a laugh, the only people that riot here are the three or four hundred, Celtic top, drug infused non educated thugs … Who have no clue why there throwing bricks
The problem is credibility. How can one believe that such a policy could succeed with fragmented political oversight. The ECB could launch such a policy in good faith but one can imagine the German Bundestag getting very nervous if there was a major speculative attack requiring the ECB to take up say 10% ot Italian debt.
The markets will remain unsettled until such time as the eurozone members surrender fiscal control to the centre. Such controls could be limited to the budgetary envelope – size of deficit etc. leaving individual states to set their own taxes within mandatory limits. Shared soveriegnity?
I think Joe Weisenthal might be having a bit of a lend of us in this article. If the ECB capped interest rates within the EU it would make the EU very attractive to Islamic banking, to the exclusion of western banks. Islamic banks don’t charge interest on loans. They have a number of other very clever mechanisms for cost recovery without charging interest. Joe would know this, maybe he’s really advocating for Arab oil money to underwrite EU the same way China underwrites the USA.
Irish trade unionists don’t protest because they are almost all in the public sector and they have already arranged to suck the German Taxpayer dry via Benchmarking and the Croke Park Agreement.
If you offer the markets a take it or leave it option, you will probably find the Market leaving it.
Last week the EFSF failed to raise €3 billion intended for Ireland. Even Germany has had failed auctions.
The fact is there will continue to be an increasing numbers in the Market trying to raise credit. Lenders can become increasingly fussy who they lend to.
http://www.zerohedge.com/news/german-10-year-bund-auction-fails-cover-issuance-contagion-rages-core
This proposed solution is ultimately printing press economics. Germany and the ECB have set their face against this as it will lead to runaway inflation.
http://iconicphotos.wordpress.com/2011/08/22/hyperinflation-1921-1923/
There are many ways to do it, and this is one, but ultimately the crisis can only be resolved by making government debt a joint responsibility of all euro countries. Unfortunately all ways of doing this are illegal, including the proposal here.
I don’t agree with the general criticism of too-little-too-late that is directed at the euro governments. If Greece was fully bailed out last year they wouldn’t have bothered implementing harsh austerity. 60 year old German workers would still be paying for 50 year old Greek retirees. We need to keep dancing until the offending countries get themselves into a condition worth guaranteeing. Behind the scenes, the euro politicians need to figure out how to make this legal without a referendum which would be doomed to failure. Not exactly democratic…..
Toddy. You are clutching at straws.
In what way?
have your say