Friday, September 07, 2012

The limits of the ECB bond purchase decision

The intervention by the European Central Bank (ECB) to buy short-term sovereign debt (3 years or less) in the secondary markets (their charter limits direct purchase of such debt) not only gave the stock market a nice boost. It initially achieved its main purpose, which was to reduce the borrowing costs of the eurozone "periphery" countries.

Spain's short-term interest rates sank by over half, as reported in Staatsschulden, EZB-Entscheid drückt Zinskosten für Krisenländer Spiegel Online 07.09.2012. Portugal and Italy also saw their bond interest rates shrink. There were even reductions in the longer-term debt.

The ECB purchases are good news, so far as they go. Paul Krugman considers it "a step in the right direction, probably enough to buy a significant amount of time, but not enough unless more follows." (Draghi 09/07/2012)

Peter Coy writes about the limits of the ECB action in Four Reasons Draghi’s Plan Alone Won’t Save Europe Bloomberg Businessweek 09/06/02012. One is that it focuses on short-term paper, "but it's not the cost of credit in the short term that’s the problem in Europe. The problem is sky-high long-term rates."

The most serious one in my mind is that austerity is working against the aims of the ECB and any serious plan to save the euro. "The more Spain cuts spending, the higher its unemployment is likely to go," he gives as an example. And the more the economy shrinks, the greater the percentage of debt to GDP becomes. And under the EU's current policies, that means that the EU (read: Germany) will apply even more pressure for austerity. And the economic death-cycle so favored by German Chancellor Angela Merkel's policies will continue.

Coy makes an interesting point I haven't seen mentioned elsewhere. Because the ECB is buying in the secondary markets, not directly from governments, there is likely to be heavy pressure by the governments with high borrowing costs on the banks in their countries to buy sovereign debt. "The problem with interdependence is that banks and sovereigns are dragging each other down," writes Coy, and the ECB purchasing scheme could actually exacerbate that problem.

His fourth point goes to the fundamental problem with the euro currency union: "The ECB is doing the best it can, but it can’t deal with the fundamental problem of the euro zone, which is that the 17 nations share a currency but don’t have a banking or fiscal union to go with it."

Christoph Schwennicke in Cicero reads Draghi's action as a policy "coup" against the German Chancellor, Merkels kalte Entmachtung 07.09.2012. Because Angie had bitterly opposed more aggressive action by the European central bank and her ally, Angiebot Jens Weidmann, the head of the German central Bundesbank who sits on the ECB board, voted against the policy.

But Angie and her Finance Minister Wolfgang Schäuble are both publicly defending Draghi's decision. (Kauf von Staatsanleihen. Merkel billigt neuen Kurs der EZB Spiegel Online 07.09.2012) For Angie, whose rigidity over her insistence on austerity, austerity, austerity for countries other than Germany has likely doomed the "European project" (the EU) already, this change of position is consistent with her continuing practice of allowing just enough to be done to avoid immediate collapse of the euro , but not much more. And, as noted above, as important as this action is, ECB purchases of short-term sovereign debt alone won't save the euro or end the recession, much less pull the eurozone out the longer-term depression.

And the EU governments are probably facing major pressure behind the scenes from the US government to postpone any new financial collapse until after the November US Presidential election. Obama mentioned preventing the European crisis from spreading as a major goal of his second term in his acceptance speech at the Democratic National Convention last night.

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