It is interesting to compare brokers’ assessments of the European stalemate with the posts and comments on MB. After all, it is the markets that decide whether Europe is salvageable; if they deem that it is, it is. If they deem it is not, then it will probably not be. In that sense we are seeing the Euro put to the same type of test that it was designed to avoid. It came into existence because George Soros and others showed that central banks could become hostage to financial markets. When the exchange rate mechanism did not work, next step was a common currency. It now looks like it simply delayed the growing power of markets over government actors. Yes, government profligacy, especially in Greece, created some of the triggers, but it was mainly the banksters and their insane debt games that caused the current problems. This seems to have been conveniently forgotten as the markets now turn up heir nose at governments and demand more austerity.
So appeasing the Leviathin is the main game. JP Morgan is not impressed with individual governments and is looking to the centre, if there is such a thing:
With Euro area governments still reluctant to significantly enlarge the EFSF or introduce Eurobonds, many are looking to the ECB as the only institution capable of solving the region’s sovereign crisis. Some suggest that the ECB should simply ramp up its purchases of government bonds through its Securities Markets Program (SMP), which it could do by creating more reserves (i.e., printing money). However, this strategy would bear huge risks and the ECB has little appetite for following it. Instead, the central bank sees clear limits of its policy tools—it is willing to act as a safety valve against short-term stresses in financial markets but it cannot solve what is ultimately a crisis of fiscal policy and solvency. As a result, the ECB will always force the ultimate resolution of the crisis back to politicians.
How big are the safety valves?
It is not hard to see why some may argue that the ECB could expand its balance sheet much more aggressively in response to the sovereign crisis. The total size of its bal- ance sheet has increased around 50% since 2007, which compares to an increase of around 200% for the Fed. In addition, around 80% of the increase has been driven by the more obscure and inactive balance sheet categories, such as valuation gains due to the higher price of gold and increases of the investment portfolios, which are held partly for operational reasons and as counterparts to the central bank’s capital. In contrast, the €110 billion of gov- ernment bond purchases make up just 5% of the balance sheet at present. And despite providing as much liquidity to banks as they demand, the aggregate amount lending is not a lot higher than it was in 2007 (although changes in the distribution of this lending matter at least as much as the total amount, see box).
The intriguing thing about this is that when you have the euro and the $US being so large and the yuan linked to the $US, then the markets critique, attack, call it what you will, starts to look dangerously self destructive. In a sense, returning to the bad old days when the markets could only take out The Bank of England or Banco de Espana is preferable to an attack on a whole region, economic zone. They cannot take out the greenback, because the greenback is so central to what they do. But when it comes to Europe, they can bring down the currency.
What I suppose we are witnessing is a battle to protect size (the euro) over flexibility (individual currencies for Europe). When it comes to protecting the system from breaking, flexibility is probably preferable. But that will leave the greenback as the world’s reserve currency, which is highly inflexible. In any case, JP Morgan looks at the political implications of the ECB’s options:
The ECB’s actions remain a huge source of support to the region and the central bank is justifying them with reference to its mandate: ensuring financial stability by supporting banks, and delivering price stability by improving the functioning of the monetary policy transmission in the bond market. It’s independence, however, is strongly rooted in European treaties, which mean politicians cannot coerce it to ramp up or even continue with its SMP purchases against it’s wishes. While the ECB will continue to act as a short- term safety valve against market stresses, it can use its independence to push governments in the right directions—setting limits to its interventions in terms of quantity or the duration of time it is prepared to act. And the ECB’s reluctance to go “all in” with a much larger commitment to monetize peripheral bonds reflects a deep tradition of stability-oriented policy, inherited from the Bundesbank. This means recognizing that central bank liquidity can only buy time but not solve a crisis of fiscal policy and solvency. And it means accepting some near-term stress if it helps to reach a more stable medium-term outcome.
I wonder why no-one looks much at the political implications of allowing markets such hegemony.
JPM_ECB Can Act as a Safety Valve, But Will Not Solve the Crisis (Research Note)_2011-08!26!666075