Ted: I think it might work, Dougal. I know it’ll work. It will work.
Dougal: It won’t work, will it Ted?
Ted: …It won’t, no.
Either Father Ted, or an imagining of the ECB meeting last Thursday which has given us the latest plan
The bond markets went berserk this week with euphoria at the leaking of, and then the confirmation of, the latest ECB plan to deal with the simple facts that banks in Europe are still nursing huge uncrystallised losses and countries are running up deficits and households, businesses and countries have colossal levels of debt, levels which are arguably unsustainable. The ECB is now set to pump “an unlimited quantity” of money into countries and banks around Europe, and the markets love it and you could almost see a “Mission Accomplished” banner scrolling across Bloomberg terminals on Thursday.
But stand back and take a look at what the ECB is doing and you may conclude that not only is the concept underpinning the plan unfeasible, but there are major problems with the technicalities.
The problems with the technicalities are simple –
(1) what are the individual countries’ trigger interest rates that will prompt the ECB to intervene, and since when does the ECB get to decide that the trigger rate for Ireland should be less than Spain’s but greater than Italy’s for example, or will the ECB have a uniform trigger intervention rate, and if so why should it be any greater than Germany’s so-called risk-free rate?
(2) no matter what way you cut it, the ECB will be exposing itself to risk of default when it buys bonds. If there was no such risk, then the interest rates on Irish, Spanish and Italian bonds would be 1%, the same as Germany’s. There is risk, and what happens if the ECB makes a loss. Will Germany as the biggest backer of the ECB carry the bill for a Spanish default?
(3) The ECB says it is not printing new money and its bond buying will be “sterilized” which implies that the ECB will just temporarily print new money to buy bonds but when it sells those bonds it will burn the proceeds. But if the temporary period is years, then what does that do to inflation across the EuroZone? The ECB balance sheet is already at €3tn, what happens to the credibility of the euro and European banking if that balance sheet grows to €6tn or €10tn?
(4) What happens to Greece, whose bond prices were not affected by last week’s announcements?
The problem with the concept is even simpler –
If countries have unsustainable debt and Ireland, Portugal and Italy are already in the 120% debt:GDP zone, and Spain’s trajectory pointing to a similar level, then how does a plan which merely buys debt from a country struggling under the burden of existing debt offer a long term solution? This latest plan from the ECB yet again assumes that the problems of several countries are temporary, and once the global economy lifts, it will take Europe and peripheral European countries with it, and surely that lift can only be a short time away? But measures put in place since 2007 have all been designed to artificially prevent incomes and asset values from falling to their natural level, and losses at banks being crystallized. All this latest plan does is further distort the reality of several countries borrowing costs being naturally at unsustainable levels. Spain’s 10-year rate was touching 7% earlier this week, after the ECB announcement it fell to 5.6% – 7% was the natural level reflecting the worries about the debt of Spanish banks and regions, 5.6% is an artificial rate introduced by the ECB’s plan. Does the ECB plan change the reality financial condition of Spanish banks or regions?
The ultimate ECB plan or European plan has to involve either (a) printing money permanently which will inflate the debt away or (b) focused debt write-down and/or default. The current path is merely a temporary support which both distorts and blights the prospects of countries in difficulty.