So finally, the ECB via president Mario Draghi unleashed what seems as the penultimate “shock and awe” rescue mechanism for the EU: the supposed “unlimited but sterilized” buying of bonds.
From Bloomberg, (bold added)
European Central Bank President Mario Draghi said policy makers agreed to an unlimited bond- purchase program to regain control of interest rates in the euro area and fight speculation of a currency breakup.
The program “will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro,” Draghi said at a press conference in Frankfurt after the ECB held its benchmark rate at a record low of 0.75 percent. “Under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.”
Draghi has staked his credibility on the bond plan, which is the most ambitious yet in the central bank’s fight to wrest back control of rates in a fragmented economy and save the euro after nearly three years of turmoil. Now it’s up to governments in Spain and Italy to trigger ECB bond purchases by requesting aid from Europe’s rescue fund and signing up to conditions
“Governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial-market circumstances and risks to financial stability exist -- with strict and effective conditionality,” Draghi said. The ECB reserves the right to terminate bond purchases if governments don’t fulfil their part of the bargain, he added…
The ECB’s program, called Outright Monetary Transactions, will target government bonds with maturities of one to three years, including longer-dated debt that has a residual maturity of that length, Draghi said. Purchases will be fully sterilized, meaning that the overall impact on the money supply will be neutral, and the ECB will not have seniority, he said.
Note that ECB bond purchases have not truly been “unlimited” as they supposedly conditional to the requested “aid” by crisis stricken nations from the ESM and will be “fully” sterilized. Aside from conditionality on reforms.
As usual political terminologies matter.
The idea of full sterilization means that money will be drained from the other sectors and will allegedly be neutral. This could be the reason behind the underperformance and the tepid gains of gold and other commodities as oil and copper despite the ECB's opening of the inflation spigot.
Moreover, perhaps too, the ECB assumes that need for bond buying may be checked or will have the desired effect of providing carrot and stick approach for governments to take appropriate corrective fiscal measures.
Unfortunately this won’t likely be the case.
Not only is the bond buying going to be an incentive for delaying the necessary reforms for the PIGS (out of moral hazard dilemma), but the ECB’s sterilization activities will likely be also restricted.
University of Chicago Professor John Cochrane at the Bloomberg explains…...
If past were to rhyme, in November of last year, the ECB has missed sterilizing her purchases.
So if the ECBs action to sterilize are encumbered, then this means either that the ECBs buying will have short run effects, or that designated conditions represents smoke and mirrors which may pave way for the massive unsterilized actions or monetary inflation.
Nonetheless, I think the ECB’s unlimited option has been coordinated with the US Federal Reserve.
Just a few days back, four Federal Reserve presidents discussed of the same open-ended buying option.
From another Bloomberg article,
Federal Reserve Chairman Ben S. Bernanke says the U.S. economy is “far from satisfactory.” His colleagues are moving to embrace policies that will stay in place until he’s satisfied.
Four Fed presidents have come out in favor of an open-ended strategy for bond buying, with three calling for the program to begin now. Rather than specify a fixed amount of bonds to purchase by a certain date, such a strategy would leave the Fed able to announce a pace of purchases that it could adjust as the economy gets closer to Bernanke’s goals.
“You would be able to react to the incoming data in an incremental way and not be in a situation where you have to either drop the bomb or do nothing,” St. Louis Fed President James Bullard said in an interview last week during the Fed’s annual monetary policy symposium in Jackson Hole, Wyoming.
Bernanke used the forum to defend unorthodox policies such as bond purchases and made the case for further action to reduce an unemployment rate that he called a “grave concern.” Stocks and Treasuries jumped after the speech as investors increased bets the Fed will opt for further easing as soon as its next meeting Sept. 12-13.
I am inclined to the view that the FED will move to compliment the ECB for political reasons. I think that Bernanke’s tenure depends on President Obama’s re-election and thus would work to ensure of policies that will be “stock market friendly”
And as I previously said, the combined actions by central banks will eventually lead to deepening stagflation manifested through high consumer prices and the real risks of a food crisis that amplifies risks of social instability, as well as, overseas bubbles.
Central bank fixes has only short term narcotic effects, that risks long term unintended consequences.
As the great Professor Ludwig von Mises presciently warned,
But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.
For now, the risk ON “orgy of speculation” environment may have been activated based on a partial fulfilment of market’s addiction for central bank steroids.
But given the vagueness of conditionalities from the ECB program and of the response by other central bankers to real economic events, the sustainability of such risk ON conditions remains unclear.
We are approaching the Mises moment.
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