“Without the euro, the ECB ceases to exist. That is true of no other eurozone institution. It gives it the incentive to act. It is also acting on a large scale.”
– Martin Wolf, December 28, 2011
Regular readers of this blog are well-acquainted with the thoughts of Martin Wolf, the Financial Times’ chief economics commentator. Wolf has long been among the most vocal critics of the European Central Bank, charging that its refusal to act as the eurozone’s lender of last resort has worsened the currency union’s crisis and made it impossible to resolve that crisis.
It is therefore with considerable interest that, as suggested by the above quote, he seems to have changed his mind regarding the intentions and efficacy of the ECB’s policies and actions. Simply stated, without the euro, the ECB has no raison d’être. Like any and all institutions, it will do whatever is necessary to ensure its survival.
Wolf seems to have been greatly influenced by Mario Draghi (the ECB’s new president) who, in his interview with the FT on December 18, argued that the ECB had taken important actions during the previous week:
“We cut the main interest rate by 25 basis points. We announced two long-term refinancing operations, which for the first time will last three years. We halved the minimum reserve ratio from 2 per cent to 1 per cent. We broadened collateral eligibility rules. Finally, the ECB governing council agreed that the ECB would act as an agent for the European Financial Stability Facility (EFSF).”
Wolf’s interpretation is as follows:
Thus the ECB is determined to fund banks freely, at low rates of interest, thereby subsidising them directly and the governments they lend to, indirectly.Why lending to banks that use the money they borrow to lend to governments is good, while lending to governments directly is bad, is hard to understand. The only obvious difference is that in the case of lending via banks, the intermediaries may themselves go broke. That makes them unavoidably unreliable conduits. Yet if this complex procedure gets round theological objections to direct financing of governments, those who believe some financing of governments is now needed should be content.
In short, the recent decisions of the ECB look like a clever way of relieving the funding constraints suffered by banks and vulnerable sovereigns. This does not redress solvency concerns directly, though the subsidy may be large enough to make a difference even here, particularly for the banks. But it should mitigate – if not eliminate –liquidity constraints, which have proved of rising importance over the last year and half.
Rick Shapiro says:
True, the ECB is injecting money into the troubled periphery nations, through a backdoor method. The chosen method avoids the political problem that would ensue if Germany and other countries of the North were to directly bail out the south. This is a type of reflation; it may well help confidence over the next few months and defer potential sovereign debt crises. Wolf had argued that this was necessary (not sufficient) for the health of the Eurozone.
But it doesn’t solve the balance of payments problem (current account). That is supposedly the job of austerity. What we have is a way of continuing the transfer payments necessary to keeping the system afloat. This would be fine if there was some other path being pursued simultaneously to solve the underlying problem. But this method of loaning to the NCBs has its limit: the ability of the banks to offer collateral. At the same time it creates a new type of contagion: the creditworthiness of the ECB is contaminated by the poor balance sheets of some of the NCBs. Nor is this method efficient because any bank can get the money, whether from a periphery country or not; thus it is less targeted. A further problem is that the banks may or may not use the new funds in productive ways. Can we be sure that they will use it to buy sovereign debt, or will they opt for some nefarious deal that is in the interest of the bank.
My guess is that if the euro does break up, this will make the mess even greater. But for now, we may see some optimism, so I’m not short the market. Maybe there is some hope that this will buy enough time for other cures to be put in place. But the history of this crisis is that the politicians only adopt short term palliatives and fail to address the fundamental issues realistically. Therefore, I am not long term bullish.
December 28, 2011, 9:09 pmMarc Schulman says:
Rick,
I think your analysis is spot-on. Judged by what I’ve been reading lately, it seems that the focus of concern is starting to shift from sovereign and bank solvency (the two being completely intertwined) to the solvency of the ECB, the reasons being that the ECB’s balance sheet is growing rapidly and the quality of the assets it’s accumulating continues to decline. Normally (whatever that means), this would give rise to growing inflationary concerns, as it would require the ECB to turn up the printing presses. But, thanks (I use the word loosely) to Germany’s demand for austerity throughout the eurozone, the velocity of money will be declining, so rapid money supply growth won’t translate into inflation any time in the foreseeable future.
If market participants believed that the ECB’s liquidity injections were presaging a spike in inflation, gold’s price would be rising. In fact, it’s been falling.
December 28, 2011, 11:16 pmtophat says:
How foolish to imagine that a “politically indirect” method can ever solve these problem. The problems are 1) th tyranny of the the EU and its power grubbing agenda, and 2) European Socialism in general. The problems are of a fundamental level and not such that can be solved be tinkering around the edges with various funding tactics or stratagems of any sort, and most certainly cannot be solved by anything remotely approaching this sort of transparent dishonesty. All this will do is make matter worse.
This is just kicking the can down the road. All it really accomplished is to put out in clear daylaight the cowardice and the venality of the ruling classes of the EU.
This cannot but end badly. Mincing about with pseudo intellectual jaw-boning about “policy implications” or proffering amateurish, arm-chair “market analysis” in order to somehow “validate” these shameful tactics, is rather beside the point, and, frankly, embarrassing to behold. These are merely attempts to distract and evade. The real truth is that the EU cannot not possibly survive if the great nations, peoples and cultures of Europe are to survive.
It is as thought we ahve cast aside all the lessons learnt in the prior two centuries.
The sooner the EU collapses and the Euorcrats removed from power the better it will be for Europe–and the world at large–in the long term.
To imagine that this sort of legerdemain can possibly work is the worst sort of foolishness.
December 30, 2011, 1:48 pm