Sovereign Bond Buying by ECB No Longer Taboo
Reuters reports that the governor of Belgium’s central bank and ECB council member Luc Coene has come out in support of full-fledged quantitative easing by the ECB in the form of sovereign bond purchases. Not surprisingly, he too is singing from the “deflation danger” hymn sheet:
“The European Central Bank should start buying government bonds to tackle poor investor confidence and low inflation in the euro zone, governing council member Luc Coene said in an interview published on Saturday.
The Belgian central bank chief said the bank had already waited too long, and that this could be one tool to spur economic activity in the 18-country euro zone and fight off deflationary pressures.
“In this context, the purchase of sovereign bonds could prove to be an effective tool,” he told La Libre Belgique.
“Since the beginning of 2014, we have systematically underestimated deflationary effects…if we were to find ourselves at the beginning of next year with negative inflation and fall into a deflationary spiral, the effects on the behavior of households and businesses could be very negative.”
Inflation in the single currency area was 0.3 percent year-on-year in November, well below the ECB’s headline target of inflation below, but close to 2 percent.
As we pointed out last week, the only central banker in Europe who hasn’t yet completely lost his mind over the alleged “danger” of the prospect of ever so slightly declining consumer prices is BuBa chief Jens Weidmann (see: “Mr. Nein” for details).
Moreover, prices are in fact not (yet) declining in the euro area overall. There are of course differences from country to country, with mildly declining prices recorded in several of the “crisis countries” – which is to say, precisely the countries that most urgently need lower prices – while prices are rising rather rapidly in others (e.g. in Austria, the annual change rate in CPI is close to the 2% target that allegedly produces economic bliss).
There are several more signs that the ECB is getting ready to crank up the printing presses for real. Not only is it clear that the securities purchase programs currently underway won’t suffice to blow up its balance sheet by the planned amount of € 1 trillion, but it seems that Germany’s central bank may give its nod to sovereign bond “QE” if the peripheral countries agree to take on relatively more risk.
Luc Coene stands ready to grab imaginary deflation by the throat.
Photo credit: Belga
As an aside to this, since we mention the figure of € 1 trillion above, it has occurred to us that when one talks about money, debt, monetary policy, derivatives, etc., these days, the numbers used in these contexts are of a size that not too long ago was held to be the sole preserve of astronomy.
We therefore propose to introduce the parsec into financial lingo in preparation for the next few decades. The parsec is an astronomical measure of distance, amounting to approximately 3.26 light years, or 31 trillion kilometers, resp. 19 trillion miles. A parsec of euros would e.g. be a stack of 10 euro notes of one parsec in height (which would be about 69 parsecs of 10 ruble notes at the current exchange rate).
The euro area’s “harmonized index of consumer prices” (HICP) and its year-on-year change rate. As you can see, money in the euro area has lost a lot of its purchasing power since 1990, even using official data. Evidently it is not a very useful store of value. Nevertheless, allegedly more euro need to be printed urgently – click to enlarge.
Full-Fledged QE by ECB Becomes More Likely with Germany Naming Conditions
According to a Reuters report published last week, the ECB is trying to find ways of getting the “hawks” who are distrustful of sovereign bond purchases on board, by tying QE to certain conditions with respect to risk sharing. Here are a few pertinent excerpts from the report:
“European Central Bank officials are considering ways to ensure weak countries that stand to gain most from a fresh round of money printing bear more of the risk and cost. Officials, who spoke on condition of anonymity, have told Reuters that the ECB could require central banks in countries such as Greece or Portugal to set aside extra money or provisions to cover potential losses from any bond-buying, reflecting the riskiness of their bonds.
Such a move could help persuade a reluctant Germany to back plans to buy state bonds.
There is currently a stand off between the ECB and Germany’s Bundesbank over ECB preparations to buy sovereign bonds, so-called quantitative easing (QE), to shore up the flagging euro zone economy.
But while the idea may help overcome opposition in Germany, which is worried that fresh money printing could encourage reckless spending and leave it to pick up the tab, critics will argue that any such conditions curtail its scope and impact.
The national central banks would most likely be the ones tasked with buying their country’s bonds, as part of a wider ECB program. While easing the burden on countries like Germany whose bonds are highly rated, the ECB could place a heavier burden on more risky countries such as Greece, requiring them to set aside more money in order for the ECB to buy their debt.
It now costs roughly 1.1 million euros ($1.35 million) to insure 10 million euros of Greek bonds against default, for example, making it roughly half as risky as war-torn Ukraine.
The Bundesbank is demanding that any new round of bond buying be subject to strict limitations. Its president, Jens Weidmann, this week outlined two such possibilities – restricting ECB buys to bonds of countries with a top-notch credit rating or allowing each central bank to buy their country’s bonds at their own risk.
As far as we can tell, this makes little practical difference, mainly because the political class in Europe won’t allow any of the countries in fiscal difficulties to default anyway. This means that the only risk is that of a sudden loss of confidence in the currency as such, a fate which all central banks engaging in QE are tempting. The greatest risk to the euro experiment in the medium term however remains that at some point a political party that rejects the euro could be elected and upset the apple cart.
As we have pointed out recently, in spite of the fact that there is a real risk now that Syriza could soon become Greece’s biggest party in parliament (keep in mind that the winning party in a Greek election automatically receives an additional 50 of the 300 parliamentary seats available), the party no longer plans a return to the drachma. It is different – at least for the time being – with the Front National in France and Beppe Grillo’s 5-Star movement in Italy, both of which are rejecting the euro outright.
So from a practical perspective, what counts about the above is actually not the distribution of risk among national central banks in the euro system. Rather, it is the fact that apparently a method is being prepared that will enable the ECB to engage in sovereign bond purchases in a manner that allows the BuBa to save face. We conclude from this that full-fledged QE is indeed coming to the euro area shortly. Manipulating the market with ZIRP, combined with NIRP, TLTROs, covered bond purchases and ABS purchases is evidently no longer considered sufficient.
The ECB’s main refinancing rate (currently at a princely 0.05%) and the deposit facility rate (currently at a negative 0.20%) – click to enlarge.
Almost needless to say, in spite of relatively tame HICP data, monetary inflation in the euro area is actually quite lively:
As to the legality of sovereign bond purchases by the ECB, here is the relevant passage from the treaty that governs what the ECB may or may not do:
Operations with public entities
21.1. In accordance with Article 123 of the Treaty on the Functioning of the European Union, overdrafts or any other type of credit facility with the ECB or with the national central banks in favor of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.
Careful reading and a bit of cogitation over this passage prohibiting fiscal financing by the ECB has led us to conclude that all that is really prohibited are direct purchases of government debt from governments and their agencies, i.e., purchases in the primary markets. The buying of government bonds in secondary markets is not explicitly prohibited, even though the difference is largely technical (in theory commercial banks would end up with even larger reserves they could then use to pyramid credit upon if the central bank were to buy newly issued debt directly from governments. We discussed why such a prohibition also exists for the Fed in “QE Explained” back in 2010).
Curiously, ECB council members seem to be aware that no lasting economic growth can be conjured up by money printing – at least that is what is usually suggested in their often repeated calls regarding the necessity of structural economic reforms in the euro area. This leaves one wondering why they would bother to print additional money anyway – obviously, the true reasons are not openly stated.
More money printing is very likely on the way in the euro area. The result will likely be another false dawn that will be hailed as an economic recovery, even while prices and with them economic calculation will be falsified and structural distortions in the economy will continue to pile up.
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