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!

It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!

   

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 Price Skyrockets in India after Currency Ban – Part III
      When Money Dies In part-I of the dispatch we talked about what happened during the first two days after Indian Prime Minister, Narendra Modi banned Rs 500 and Rs 1000 banknotes, comprising of 88% of the monetary value of cash in circulation. In part-II, we talked about the scenes, chaos, desperation, and massive loss of productive capacity that this ban had led to over the next few days.   Indian prime minister Narendra Modi – another finger-wagger, as can be seen in this...
  • Gold Price Skyrockets in India after Currency Ban – Part IV
      A Market Gripped by Fear The Indian Prime Minister announced on 8th November 2016 that Rs 500 and Rs 1,000 banknotes would no longer be legal tender. Linked are Part-I, Part-II and Part-III updates on the rapidly encroaching police state. The economic and social mess that Modi has created is unprecedented. It will go down in history as an epitome of naivety and arrogance due to Modi’s self-centered desire to increase tax-collection at any cost.   Indian jewelry...
  • A Note on Gold and India – What is Driving the Gold Price?
      Hidden Motives It is well-known that India's government wants to coerce its population into “modernizing” its financial behavior and abandoning its traditions. The recent ban on large-denomination banknotes was not only meant to fight corruption.   Obviously, this very bad Indian has way too much cash. Just look at him, he looks suspicious! Photo via thenewsminute.com   In fact, as our friend Jayant Bhandari has pointed out, fresh avenues for corruption ...
  • Gold Price Skyrockets in India after Currency Ban – Part V
      A Brief Recap India's Prime Minister announced on 8th November 2016 that Rs 500 and Rs 1,000 banknotes will no longer be legal tender. Linked are Part-I, Part-II, Part-III, and Part-IV, which provide updates on the rapidly encroaching police state Expect a continuation of new social engineering notifications, each sabotaging wealth-creation, confiscating people’s wealth, and tyrannizing those who refuse to be a part of the herd, in the process destroying the very backbone of the...
  • Attaining Self-Destruct Velocity
      Bad Monday Some Monday mornings are better than others.  Others are worse than some.  For one Amazon employee, this past Monday morning was particularly bad. No doubt, the poor fellow would have been better off he’d called in sick to work.  Such a simple decision would have saved him from extreme agony.  But, unfortunately, he showed up at Amazon’s Seattle headquarters and put on a public and painful display of madness.   Good-bye cruel world! On this our planet,...
  • All Aboard! Trump’s Express Train to the Future
      Free Money! BALTIMORE – Last week, the Dow punched up above 19,000 – a new all-time record. And on Monday, the Dow, the S&P 500, the Nasdaq, and the small-cap Russell 2000 each hit new all-time highs. The last time that happened was on the last day of December 1999.   Ironically, two events that were almost universally expected to trigger large stock market declines were followed by quite rapid and strong gains. Would the market have fallen if Hillary Clinton had won...
  • India's Currency Debacle – An Interview with Jayant Bhandari
      A Major Crisis Last week Jayant Bhandari related the story of the overnight ban of certain banknotes in India under cover of “stamping out corruption” (see Gold Price Skyrockets In India after Currency Ban Part 1 and Part 2 for the details).   Banned 500 rupee banknotes   The problem is inter alia that the sudden ban of these banknotes has hit the Indian economy quite hard, given that 97% of all transactions in the country are cash-based. Not only that, it has...
  • Will the Swamp Swallow Trump?
      Permanently Skewed TRUMP HOTEL, New York – Trump’s rambling army – professionals, amateurs, camp followers, and profiteers – is marching south, down the I-95 corridor. There, on the banks of the Potomac, it will fight its next big battle.   Lieutenants in Trump's army: Bannon, Flynn & Sessions Photo credit: Drew Angerer / AFP   Here at the Diary, we do not like to get involved in politics. But this is a special time in the history of our planet – a...
  • There Are Two Types of Credit — One of Them Leads to Booms and Busts
      Stumped by the Bust In the slump of a cycle, businesses that were thriving begin to experience difficulties or go under. They do so not because of firm-specific entrepreneurial errors but rather in tandem with whole sectors of the economy. People who were wealthy yesterday have become poor today. Factories that were busy yesterday are shut down today, and workers are out of jobs.   What has caused the bust? The modern-day economic orthodoxy continues to be unable to provide...
  • Gold Bull Market Remains Intact – Long Term Fundamentals Outweigh Short Term Market Gyrations
      A Strong First Half of the Year, Followed by Another Retreat In early 2016 gold had a big bull run. The precious metal rose close to 25% this year, pushed higher in a summer rally that peaked on July 10th. Gold experienced a bumpy ride over the remainder of the summer though, as investors became increasingly concerned about a potential rate hike by the Federal Reserve. Uncertainty returned to gold market and has intensified further since then.   Initially, gold rallied sharply...
  • Too Early for “Inflation Bets”?
      The Trump Trade After 35 years of waiting... so many false signals... so often deceived... so often disappointed... bond bears gathered on rooftops as though awaiting the Second Coming. Many times, investors have said to themselves, “This is it! This is the end of the Great Bull Market in Bonds!”   The long bond's long cycle – red rectangles indicate when the post 1980 bull market was held to be “over” or “over for sure” or “100% over”, etc.  We have...
  • US True Money Supply Growth Jumps, Part 1: A Shift in Liabilities
      A Very Odd Growth Spurt in the True Money Supply The growth rates of various “Austrian” measures of the US money supply (such as TMS-2 and money AMS) have accelerated significantly in recent months.  That is quite surprising, as the Fed hasn't been engaged in QE for quite some time and year-on-year growth in commercial bank credit has actually slowed down rather than accelerating of late. The only exception to this is mortgage lending growth - at least until recently. Growth in...

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