Central Bank Policy Implementation and the ECB's Plan

In order to avoid the appearance that its plan to buy bonds of peripheral governments does indeed amount to 'funding of governments by the printing press', the ECB has tied the plan to the condition that it has to happen in parallel with EFSF/ESM rescues. However, that was not all – there was another  stipulation mentioned by Mario Draghi during the press conference. We briefly remarked on this already in our summary and analysis of the ECB decision last week.  

The other part of the plan,  which is supposed to make the operation more akin to a 'monetary policy' type intervention,  is to concentrate the buying on the short end of the yield curve. The thinking behind this is that in 'normal times', the central bank is mainly aiming to manipulate overnight rates in the interbank funding markets as well as other very short dated interest rates rates. Hence intervention in the short end of the curve closely resembles this 'normal' implementation of monetary policy. With this, the ECB probably also tries to differentiate its actions from those of the Fed and BoE.

 

Usually, the central bank determines a 'target rate' for overnight funds, and whenever credit demand wanes and interbank rates drift below this target, it is  supposed drain liquidity. Whenever credit demand threatens to push interbank rates above the target rate, it will add liquidity.

During boom times, very little 'draining' tends to happen. As a rule, central bank target rates will be too low, and as speculative demand for short term credit keeps increasing during a boom,  its liquidity injections – which provide  banks with the reserves required to keep the credit expansion going – will aid and abet the growth in credit and money supply initiated by the commercial banks.

In the euro area, this method of overnight rate targeting has produced roughly a 130% expansion of the true money supply in the first decade of the euro's existence – about twice the money supply expansion that occurred in the US during the 'roaring twenties' (Murray Rothbard notes in 'America's Great Depression' that the US true money supply expanded by about 65% in the allegedly 'non-inflationary' boom of the 1920's).

This expansion of money and credit is the root cause of the financial and economic crisis the euro area is in now. This point cannot be stressed often enough: the crisis has nothing to do with the 'different state of economic development' or the 'different work ethic' of the countries concerned. It is solely a result of the preceding credit expansion.

Since long term interest rates are essentially the sum of the expected path of short term interest rates plus a risk and price premium, the central bank's manipulation of short term rates will usually also be reflected in long term rates.

In the euro area's periphery, the central bank has lost control over interest rates since the crisis has begun. The market these days usually expresses growing doubts about the solvency of sovereign debtors by flattening their yield curve: short term rates will tend to rise faster than long term ones. This in essence indicates that default (or a bailout application) is expected to happen in the near future. It is possible that this effect has also influenced the ECB's decision to concentrate future bond buying on the short end of the yield curve. However, as is usually the case with such interventions, there are likely to be unintended consequences.

 

 

The Rollover Problem

 

Recently the bond maturity profile of Italy and Spain looked as depicted in the charts below. Note that the charts are already slightly dated (this snapshot was taken at the beginning of the year), so there may have been a  few changes in the meantime, but they probably still represent a reasonably good overview of the situation:



 

Italy's debt rollover schedule, 2012-2021 – click chart for better resolution.

 


 

Spain's debt rollover schedule, 2012-2021 – click chart for better resolution.

 


 

There has been an enormous shift in the maturity schedule of the debt of both governments when we compare these charts to the situation as it looked in May of 2010, when the following snapshots were taken:

 


 


Italy's debt rollover schedule as it looked in May of 2010 – click chart for better resolution.

 


 

As of mid 2010, Italy had €168.2 billion of debt coming due in 2012. At the beginning of 2012, this had increased to € 319.6 billion – a near doubling. In Spain, the change is even more extreme:

 


 

Spain's debt rollover schedule as it looked in May of 2010 – click chart for better resolution.

 


 

In mid 2010, € 61.2 billion of bonds were expected to mature in 2012. At the beginning of 2012, this number had swelled to €142.2 billion.

What accounts for this enormous change? When interest rates began to rise sharply, the governments of Spain and Italy ceased to issue long term debt, opting to shorten the maturity spectrum of their debt instead. This was  done because long term interest rates had become too high for their taste. It was no longer considered affordable to finance the government at these rates when they exceeded 6% and later temporarily even 7%. 

Thus panic began to set in when short term interest rates began to rise sharply  as well in November of 2011 and again from March 2012 onward.

 


 

Spain's 2 year government bond yield  –  it was the increase in these short term rates that made it impossible for Spain's government to continue financing itself without help – click chart for better resolution.

 


 

Now we can already see what the problem with the ECB's plan is: it will tend to shorten the average maturity of peripheral debt even further once it is implemented. In fact, it already has this effect even before the ECB has bought a single bond, as rates on the short end of the curve have recently fallen sharply in reaction to the announcement.

As Bloomberg reports:

 

“European Central Bank President Mario Draghi’s bid to bring down Spanish and Italian yields may spur the nations to sell more short-dated notes, swelling the debt pile that needs refinancing in the coming years.

[…]

“In a way what the ECB has done is making the situation worse,” said Nicola Marinelli, who oversees $160 million at Glendevon King Asset Management in London. “Focusing on the short-end is very dangerous for a country because it means that every year after this they will have to roll over a much larger percentage of their debt.”

The average maturity of Italy’s debt is 6.7 years, the lowest since 2005, the debt agency said in its quarterly bulletin. The target this year is to keep that average at just below seven years, according to Maria Cannata, who heads the agency. In Spain, where the 10-year benchmark bond yields 6.94 percent, the average life is 6.3 years, the lowest since 2004, data on the Treasury’s website show.

“Driving down the short-dated yields provides a little bit of comfort and encourages Spain and Italy to issue more at the short-end,” Marc Ostwald, a strategist at Monument Securities Ltd. in London, said. “The problem is that you are building up a refinancing mountain.”

 

(emphasis added)

Even if the ECB buys the bonds of Italy and Spain, they will still have to repay them and regularly roll them over at maturity. By inducing them to shorten the average maturity of their debt further, the ECB creates new risks, especially as the economic downturn remains in full swing and is likely to worsen the fiscal situation of both countries in the short to medium term.

Interestingly, a similar shortening of average debt maturities can be observed in the euro area's 'core' countries. France is certainly considered a 'core' country and is currently treated as a 'safe haven' by bond investors. However, this is a tenuous situation, as it can still not be ruled out that the government will eventually be called upon to bail out the country's banks. At the moment all is quiet on that front, but it was only in November last year when the market was extremely worried about the risk these banks face in view of their enormous balance sheets and potential funding problems.

 


 

France also has the vast bulk of its debt rollovers scheduled for 2012 – click chart for better resolution.

 



A similar tendency to shorten the government's debt maturity profile can be oberved in Germany:

 



Germany's debt rollover schedule, 2012-2021, as of the beginning of the year – click chart for better resolution.

 


 

Now, Germany and France are obviously not expected to have problems rolling over their debt in the near term. The problem is rather that all these countries compete for the same investment funds. In other words, the shortening of the average debt maturity in France and Germany indirectly puts more pressure on the periphery, as the total of debt rollovers in the euro area has become much larger than it was previously.

It is of course no wonder that the German treasury is eager to sell lots of debt maturing in two years or less: investors are currently stomaching negative yields on this debt, i.e., the actually pay Germany's government for the privilege of lending it money. This may be great for Germany's government finances, but it it not without risk either. After all, given that Germany is the euro area's 'paymaster', it has taken on a huge and ever growing amount of guarantees.  What if the crisis worsens and Germany's guarantees are called in? In that case it could turn out that it was a big mistake to take on so much short term debt just because it looked extraordinarily cheap.

The ECB's bond buying plan meanwhile is going to pile on even more rollover risk.

All in all we are left to conclude that the euro area's governments have  exposed themselves to additional risks that could have been easily avoided.

 


 

The history of the ECB's now defunct 'SMP', via 'Der Spiegel' – click chart for better resolution.

 



Interest rates in the UK: the BoE has also lost control over rates to some extent. There is a growing gap between the 'target rate' and the rates charged to various types of bank customers. Chart via Ed Conway – click chart for better resolution.

 


 

 


Charts by: BigCharts, Der Spiegel, Ed Conway


 
 

Emigrate While You Can... Learn More

 
 

 

Dear Readers! We are happy to report that we have reached our turn-of-the-year funding goal and want to extend a special thank you to all of you who have chipped in. We are very grateful for your support! As a general remark, according to usually well informed circles, exercising the donation button in between funding drives is definitely legal and highly appreciated as well.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

3 Responses to “The ‘Maturity Crunch’”

  • Crysangle:

    In Europe reducing short term rates may not have any desired effect on long term rates , quite the opposite . Looking at a yield curve for Spain dated July , it is/was quite clear that the yields were only reacting ‘normaly’ where liquidity was available – after 3 yrs was a flat 7% @ . Why would the yields of longer debt reduce – after all short debt has to be rolled and until there is a surplus would not be paid off but carried year to year , keeping any one country’s solvency under continued imminent pressure , which is maybe an aim. It would be interesting to find a chart which presumed all current short debt will be rolled indefinitely and drew up yearly maturities that way over time – surely investors must think this way , and when they look at what has to be paid back/rolled in say five years in reality, it must be even more off putting , no matter that that particular country has accessed some short lending at a rate that keeps its accounts afloat.

  • They keep piling it higher, it will blow higher when it goes.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Gold bars are displayed at a gold jewellery shop in the northern Indian city of Chandigarh May 8, 2012. Gold imports by India, the world's biggest buyer of bullion, could rise on pent-up demand from jewellers after the federal government decided to scrap an excise duty on jewellery it imposed in March, the head of a trade body said on Monday. REUTERS/Ajay Verma (INDIA - Tags: BUSINESS COMMODITIES)Fresh Mainstream Nonsense on Gold Demand
      They Will Never Get It... We and many others have made a valiant effort over the years to explain what actually moves the gold market (as examples see e.g. our  article “Misconceptions About Gold”, or Robert Blumen's excellent essay “Misunderstanding Gold Demand”).  Sometimes it is a bit frustrating when we realize it has probably all been for naught.   Gold wants to know what it has done now... Photo credit: Ajay Verma / Reuters   This was brought home to...
  • fir wateringDrowning the Fir
      Presidential Duties Our editor recently stumbled upon an image in one of the more obscure corners of the intertubes which we felt we had to share with our readers. It provides us with a nice metaphor for the meaningfulness of government activity. First, here is a look at the picture – just quietly contemplate it for while and let it work its magic on you:   Yes, these two gentlemen are actually watering a tree in the middle of a downpour... Photo via...
  • swiss-cultureSwitzerland About to Vote on “Free Lunch” for Everyone
      Will the Swiss Guarantee CHF 75,000 for Every Family? In early June the Swiss will be called upon to make a historic decision. Switzerland is the first country worldwide to put the idea of an Unconditional Basic Income to a vote and the outcome of this referendum will set a strong precedent and establish a landmark in the evolution of this debate.   The Swiss Basic Income Initiative in a demonstration in front of parliament. As we have previously reported (see “Swiss...
  • mossack fonsecaGold – The Commitments of Traders
      Commercial and Non-Commercial Market Participants The commitments of traders in gold futures are beginning to look a bit concerning these days – we will explain further below why this is so. Some readers may well be wondering why an explanation is even needed. Isn't it obvious? Superficially, it sure looks that way.     As the following chart of the net position of commercial hedgers illustrates, their position is currently at quite an extended...
  • picture-social-contract-not-foundHeretical Thoughts and Doing the Unthinkable
      Heresy! NORMANDY, France – The Dow rose 222 points on Tuesday – or just over 1%. But we agree with hedge-fund manager Stanley Druckenmiller: This is not a good time to be a U.S. stock market bull.   Legendary former hedge fund manager Stanley Druckenmiller at the Ira Sohn conference – not an optimist at present, to put it mildly. Photo credit: David A. Grogan / CNBC   Speaking at an investment conference in New York last week, George Soros’ former partner...
  • ClintotrumpStaying Home on Election Day
      Pretenses and Conceits The markets are eerily quiet… like an angry man with something on his mind and a shotgun in his hand. We will leave them to brood… and return to the spectacle of the U.S. presidential primaries. On display are all the pretenses, conceits, and absurdities of modern government. And now, the race narrows to the two most widely distrusted and loathed candidates.   US election circus: Deep State Rep vs. Rage Channeller   The first, a loose...
  • Jackboot 2How the Deep State’s Cronies Steal From You
      Expanding in Ireland DUNMORE EAST, Ireland – We came down the coast from Dublin to check on our new office building. For this visit, we wanted to stay somewhere different than we normally do. So we chose a small hotel on the coast, called the Strand Inn.   Irish landscape with alien landing pads. Even the guys from Rigel II have heard about Ireland's corporate tax rate. Photo credit: Tourism Ireland   It is an excellent place for seafood and soda bread on a...
  • time100-grid-covers-whiteThe World's 100 Most Influential Hacks, Yahoos and Monkey Shiners
      Hacks and Has-Beens NORMANDY, France – What has happened to TIME magazine? Henry Luce, who started TIME – the first weekly news magazine in the U.S. – would be appalled to see what it has become.   Time cover featuring the sunburned mummy heading the globalist IMF bureaucracy (which inter alia advocates that governments should confiscate a portion of the wealth of their citizens overnight, even while its own employees don't have to pay a single cent in taxes). Once you...
  • YenThe Japanese Popsicle Affair
      Policy-Induced Contrition in Japan As we keep saying, there really is no point in trying to make people richer by making them poorer – which is what Shinzo Abe and Haruhiko Kuroda have been trying to do for the past several years. Not surprisingly, they have so to speak only succeeded in achieving the second part of the equation: they have certainly managed to impoverish their fellow Japanese citizens.   Shinzo Abe and Haruhiko Kuroda, professional yen assassins Photo credit:...
  • Bank of Japan (BOJ) Governor Haruhiko Kuroda attends a news conference at the BOJ headquarters in Tokyo, Japan, December 18, 2015.  REUTERS/Toru HanaiKuroda-San in the Mouth of Madness
      Deluded Central Planners Zerohedge recently reported on an interview given by Lithuanian ECB council member Vitas Vasiliauskas, which demonstrates how utterly deluded the central planners in the so-called “capitalist” economies of the West have become. His statements are nothing short of bizarre (“we are magic guys!”) – although he is of course correct when he states that a central bank can never “run out of ammunition”.   BoJ governor Haruhiko Kuroda Photo credit:...
  • pueblos-originarios-960x623Revolution at the Ranch
      Alarming News BALTIMORE, Maryland – An alarming email came on Tuesday from our ranch in Argentina: “Bad things going on… We thought we had the originarios problem settled. Not at all. They just invaded the ranch.”   Originarios on the march... Photo credit: cta.org.ar   To bring new readers fully into the picture, Northwest Argentina, where we have our ranch, has a revolution going on. Some of the indigenous people – that is, people with Native...
  • St. HelenaThe Long-Buried Secret of Napoleon Bonaparte
      Family Secrets DUBLIN – The smart money is getting out while the gettin’ is still good. That’s the message we get from reading the recent headlines.   Here’s the Financial Times:   Redemptions from stock funds have hit nearly $90 billion this year as portfolio managers and hedge funds struggle to navigate a market that no longer seems driven by radical central bank policy.   S&P 500 Index: causing navigational problems - click to...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com