It must be infuriating for Mario Draghi, the hapless President of the European Central Bank, to see how masterfully the Fed and the Bank of Japan control their respective credit markets, how they manipulate them for the benefit of financial institutions, and how they’re allowing their governments to run up huge deficits—huge by European debt-crisis standards—and fund them at near zero cost, or below cost when adjusted for inflation. And that at the expense of entire classes of investors, savers, and people who are struggling to make ends meet. Financial repression is the term. But Draghi just doesn’t seem to be able to wrap his arms around it.
In his bailiwick, sovereign bond yields are negative at one end of the spectrum and junk-bond high at the other. Some countries, such as Greece, lost access to the markets; risk premiums had gotten too high. But the markets turned out to be correct: Greece defaulted and left behind balance-sheet wreckage across much of Europe.
By contrast, the Fed’s manipulation of the credit markets has extended thousands of miles across the country as far as California, which, like Greece, ran out of money. But instead of defaulting, it printed $2.6 billion in nice-looking IOUs in 2009 and sent them out as payment. The Fed flooded the markets with more money, which had to go somewhere, and some of it went west, so that even California was able to borrow itself out of its budget-deficit hole. That’s how a real central bank manipulates even the nether regions of its credit empire.
Draghi is livid. Certain areas of the Eurozone credit markets have escaped his control and have returned to the primordial state of a free market where participants, not central planners, negotiate prices and yields based on perceived risks. Which, as cynical tongues might say, is the definition of a sovereign debt crisis.
So on Thursday, Draghi will make another effort to gain control over uppity sections of the Eurozone credit markets. Expectations are enormous that he’d yank out a miracle weapon to fight the debt crisis; after all, he’d promised to “do whatever it takes to preserve the euro.” And he does have some weapons in his armory.
He could pull out another Long Term Refinancing Operation (LTRO), similar to the ones late last year and earlier this year, when the ECB had handed €1 trillion in ultra-cheap three-year loans to the banks, which then bought Spanish and Italian government bonds that are now decomposing on their balance sheets. Unlikely that this will be tried again anytime soon.
He could lower the quality of assets the ECB accepts as collateral. But it’s practically accepting old bicycles already, though it finally stopped accepting Greek debt, which is worth even less than old bicycles.
He could lower various rates, but they’re already near zero, or at zero, and lowering them will have minimal impact other than disrupting money markets even further.
He could print money and buy sovereign bonds in the secondary markets, similar to the program last year that left €211 billion of bonds to rot on the ECB’s balance sheet, a practice it abandoned in March after stiff German (and other) opposition; it violated the treaties that prevent the ECB, in theory, from funding government deficits.
Or he could promote a banking license for the bailout fund ESM. Ah-ha! A way around the pesky treaties. A panacea.
A banking license would allow the ESM to borrow unlimited amounts from the ECB and then use that money to buy sovereign bonds of debt-sinner countries. A perfect fig leaf for the ECB. It wouldn’t fund governments directly, but via an intermediary. Another trick in a long series to finagle a way around the treaties that form the foundation of the EU. The cost would be inflation and devaluation, not from one day to the next, but insidiously, quietly, year after year. Yet, a banking license would be “whatever it takes to save the euro.”
“‘Whatever’ means ‘whatever is authorized,’” said Chancellor Angela Merkel’s spokesman Geörg Streiter. And “a banking license for the ESM is absolutely not part of our projects.” While Merkel stated repeatedly that she’d do “everything” to protect the Eurozone, she didn’t offer a list of what “everything” would include. But it won’t include a banking license. Finance Minister Wolfgang Schäuble brushed it off. And Vice-Chancellor and Economy Minister Philipp Rösler summarized it: “The Chancellor, the Finance Minister, and I agree that a so-called banking license for the ESM cannot be our way.” Germany, he said, wouldn’t “want to take the road to an inflation union.”
So Draghi won’t have a functional miracle weapon. He’ll have to make do with words, and they will be designed to manipulate the markets, and they will be full of promise and stimulate phantasies, as if words could solve a debt crisis, or the birth defects of the Eurozone.