Yesterday, the ECB pronounced itself the official lender-of-last resort to all Euro-Zone governments. To assure that the state can always borrow at conveniently low rates has been declared an essential component of ‘maintaining financial stability’ and thus a standard plank of modern central banking. Despite all their professed differences and divergent legal frameworks, all major central banks have now become their respective governments’ inexhaustible ATMs. – Coincidence?
At the press conference yesterday Draghi declared that unlimited bond buying was really par for the course of what a central bank should do to make sure that those ‘transmission channels of monetary policy’ don’t get clogged. It is all well within the ECB’s original mandate, although Draghi thought it still necessary to blame the need for his new initiative on somebody, namely the investors who, with their ‘unfounded fears’, create ‘severe distortions’ in government bond markets.
He was evidently talking of the ‘unfounded fears’ of a breakup of the euro when what is really at the heart of the Euro Zone sovereign debt crisis is the fear of various states going bust, and that fear is anything but unfounded. The inability of most governments to reign in public spending and to end their dependence on continuous borrowing is the real reason for ‘severe distortions’ in sovereign debt markets.
The politicians and central bankers could have separated the issue of default and Euro-exit by making it clear that default is an option within the single currency. That was indeed the idea behind the original no-bailout clause. Let Greece go bust, and Spain as well, but don’t kick them out of the euro. Default is a problem between creditor and debtor, that’s all. As I said before, under the Classical Gold Standard, a government could have defaulted and nobody would have ceased to use gold as money, not even the citizens of the defaulted state. Similarly, the Californians will not be asked to leave the dollar-zone if (or when) the Californian government defaults.
Euro-exit is a political decision, not an economic necessity. The idea is to get your own central bank back, print lots of money and, that way, keep borrowing and spending. Yesterday, the ECB made it clear that exit is unnecessary as the ECB will now do all the printing for the weaker states itself.
There is no surprise here. This was all expected and it was sooner or later inevitable. Yet it does constitute a further step toward the nationalization of money and credit and the death of free markets. Here is why:
It is a matter of logic that anybody who habitually spends more than he earns and borrows the difference puts himself at the mercy of his creditors. When those lose faith in him, he will be unable to roll over his debt or borrow more, or may only be able to do so at punitively high rates. That is the flipside of living constantly beyond your means, of going ever more into debt. You need somebody to fund such extravagance. When your lenders lose trust in your ability to repay, it is ‘game over’.
But in our system of unlimited fiat money this does no longer apply to banks and governments. For these two entities it doesn’t matter what the investors and depositors - ‘the market’ – think or feel. In these cases, the central bank bureaucracy assumes the role of ultimate decision-maker. As long as the banks and the governments can convince the central bank bureaucracy that they should stay in business and keep borrowing, they will stay in business and keep borrowing, preferably straight from the printing press and without the involvement of those pesky investors with their ‘unfounded fears’. And these days it is not hard to convince the central bank.
From LTRO to OMT
The members of the political-financial complex have certainly been sticking together: bankrupt banks have been buying the bonds of bankrupt governments so that the governments could continue bailing out the bankrupt banks, and the ECB provided the cash for this charade. It used to be called LTRO – long-term refinancing operation.
Under LTRO, the ECB could pretend that it was only supporting the banks and not spendthrift governments at the same time. Supporting the banks was accepted according to the then reigning central banking orthodoxy, funding the state not so much. Late last year and earlier this year, the ECB printed EUR1,000 billion of new money and gave it to the banks, mainly banks in the Euro Zone periphery. These banks then used the money to buy the bonds of their governments.
LTRO had two flaws: EUR1,000 billion may sound like a lot of money to you and me but even EUR1,000 billion is not, well, unlimited. And because LTRO was not unlimited, it ran out at some stage, and the dire state of public finances came to the surface again. All the newly acquired government bonds were suddenly burning a new hole in the balance sheets of the already weakened periphery banks.
The central bank bureaucracy has now come up with OMT – outright monetary transactions – to address LTRO’s two weaknesses: OMT is not only unlimited, it doesn’t burden the balance sheets of the banks any longer. This is money printing from the central bank directly for the benefit of the state (even if it is conducted in the secondary market).
Of course, OMT comes with a whole range of pious promises, such as that it will only benefit governments that receive support from the ESM or EFSF, and that subject themselves to the tough conditions of these programs. The valiant efforts at fiscal consolidation will continue.
We heard this many times before. The Eurocracy is very good at imposing tough limits and restrictions on itself, only to ignore them shamelessly at the first hurdle. Remember the Maastricht treaty? The limits on government debt and budget deficits? The no-bailout clause? Every single promise has been broken by now. Besides, we have no guarantees. The ECB may change any of these conditions at the drop of a hat. All of this is entirely arbitrary. The elite is making up its own rules as it goes along.
Only the prospect of instant default and a complete cut-off from new borrowing will ever force politicians to shrink the state apparatus that is the source of their power. The political class hates ‘austerity’. So do the majority of voters. With the backstop from the printing press in place, the appetite for fiscal reform will most certainly fade. The chances that ‘austerity’ will die a quiet death have increased.
The markets’ initial response is somewhat silly, in my opinion, albeit not entirely surprising. Equities are rallying hard, in particular bank stocks. So does government debt. The euro is stronger versus other paper currencies because the risk of breakup has allegedly receded. But breakup looked unlikely even before.
In fact, no response was needed. Nothing material has changed. Like the central banks in Britain and the US, the ECB will now actively and directly support government debt with the printing press but this was sooner or later inevitable anyway. I do not see any basis for a marked divergence of any of these currencies. In all these economies the printing press is quickly becoming the last line of defense for an unsustainable system.
And the ECB’s OMT will end the depression as little as QE in the US and Britain has ended the depression there. I expect the asset rallies to peter out quickly but asset prices to remain elevated because of cheap money everywhere.
In the meantime, the debasement of paper money continues.