“Government has no other end, but the preservation of property.”-John Locke
By Mark J. Grant
One of the primary purposes of
a government, any government, is to sustain itself. In its final hours it will
do almost anything possible for its self-preservation. If the rumors are to be believed and
Draghi is going to propose unlimited bond buying in the short end of the curve
for the nations of Europe in maturities up to three years then it must be said
that Mario Draghi, personally, has re-written the treaties for the European
Union which specifically forbids what he is apparently about to undertake. In
my mind, this is an act of desperation that makes me quite nervous because my
thinking extends out past the announcement that will be made later today as I
consider its consequences, ramifications and where the focus will shift which
will be to the recession in Europe and to the fundamental financial health of
the nations in the European Union and then to the fundamental financial health
of the European Central Bank itself.
It was in January of 2010 when the yield on the Greek ten year was a 4.38% that I first stated that Greece was going bankrupt. It was several months later that I added Portugal, Ireland and Spain to the list. Three have gone and Spain is about to go and now I would add Italy to my list. The firewalls that were supposed to protect the Continent have failed miserably as exemplified by the current financial condition of both Spain and Italy. Now, in what I consider to be an act of desperation, the ECB is not only violating its mandate but putting the economics of the Continent in a perilous state and the markets are totally focused on the next few hours and not at all upon the consequences of the ECB’s decision. I am not surprised by this but I am reminded of the moments before the Lehman disaster when the relative calm did not predict the firestorm which was to ravage the world. The echoes remain; “WE SHOULD HAVE KNOWN,” and I am fearful that we may have another of these moments as people consider the consequences of the ECB’s actions incorrectly.
Unlimited bond buying in the short end of the curve means that not only will the yield curve steepen significantly but that all of the financing will take place in the “ECB Funding” part of the curve. This then means that a tremendous amount of debt accrues to the front-end of the yield curve and must be rolled regularly while the amounts will be increasing not only because of the placement of the maturities but because Spain and Italy, as examples, need to borrow ever larger amounts of money to finance themselves as they sink into worsening recessions. Since the ECB apparently is proposing to sterilize their purchases then the money supply will not be expanding and so as the debt load increases the primary funding, the national debt auctions, will have an increasing difficulty finding buyers.
The ECB’s actions also means that their balance sheet will be expanding. The ECB is already at $4 trillion, almost twice the size of the America’s Fed, and it is about grow much larger. This also has consequences. Regardless of market perception, there is no such thing as “Free Money” and the liabilities of the ECB are borne by the various central banks of Europe and by the nations that own them. As the ECB expands its balance sheet “without limit” the credit quality and the risk profile of the various owners of the ECB correspondingly declines. Peter always pays Paul in the real world and the expansion at Europe’s Central Bank is off-set with a deterioration of the national credit quality of the nations so that the entire construct sets itself up for the possibility of being downgraded by the nemeses of Europe, the ratings agencies, because they cannot control them. A “AA” Germany and/or a “AA” Europe Union is quite a different animal than a “AAA” one no matter the rhetoric of Brussels and Berlin.
Conditionality
While everyone stares at Frankfurt and the last ditch effort of Mr. Draghi there have been other events which are part of this play and merit your attention. Austria has come out and stated quite succinctly that no more Austrian money will be used for other countries; any other countries. Yesterday the Netherlands stated in absolute terms that no more of their money will be used for Greece. If the condition of any ECB funding is to be the approval of the EU and the use of their Stabilization Funds then what the Mario Draghi is proposing may never come to pass, may never happen and may just be a rhetorical exercise in wand waving. If the EU refuses to fund Greece, Spain, Italy et al then under the current apparent plan, the ECB would do/could do nothing but sit and flail in the wind. I suppose that the ECB could step-up and buy all of the debt of Europe and declare the nations of Europe a “Debt Free Zone” and perhaps the markets would rally on a $100 trillion ECB but then Germany, being accountable for 22% of the ECB would have a liability of $22 trillion with an economy of $3.55 trillion but the number would never get counted in Europe because it is a contingent liability except that those who fund are not quite that dumb and some have gotten the punch-line earlier than others and are not funding now. The “condition” of all of this promised ECB funding may prevent it being actualized and this seems to be something that almost no one is taking into account.
A Frightening Possibility
To me, the world seems askew at present. China is in serious decline, Europe is in a virtual recession as Eurostat releases the numbers today and points to a -0.2% contraction of the EU-17. The markets rally based upon the supposed three Saviors of the world, the central banks of the United States, Europe and China and so the worse that it gets the larger the rally as the central banks will ease and ease again until some kind of wall is hit. The financial markets rest upon two tenets which are the focus of the market and the perception of those funding. The Great Depression is largely thought to have been sparked by the failure of an Austrian bank. We have watched Dexia, Bankia and several Austrian banks go by the wayside already and so far the markets have ignored the pattern of warning. Spain is going to be forced to the till and if funding is cut off and then if Italy arrives in the same line and various nations refuse to fund then we have arrived at the place where the rock meets the hard place and where hopes and prayers run dry.
It was in January of 2010 when the yield on the Greek ten year was a 4.38% that I first stated that Greece was going bankrupt. It was several months later that I added Portugal, Ireland and Spain to the list. Three have gone and Spain is about to go and now I would add Italy to my list. The firewalls that were supposed to protect the Continent have failed miserably as exemplified by the current financial condition of both Spain and Italy. Now, in what I consider to be an act of desperation, the ECB is not only violating its mandate but putting the economics of the Continent in a perilous state and the markets are totally focused on the next few hours and not at all upon the consequences of the ECB’s decision. I am not surprised by this but I am reminded of the moments before the Lehman disaster when the relative calm did not predict the firestorm which was to ravage the world. The echoes remain; “WE SHOULD HAVE KNOWN,” and I am fearful that we may have another of these moments as people consider the consequences of the ECB’s actions incorrectly.
Unlimited bond buying in the short end of the curve means that not only will the yield curve steepen significantly but that all of the financing will take place in the “ECB Funding” part of the curve. This then means that a tremendous amount of debt accrues to the front-end of the yield curve and must be rolled regularly while the amounts will be increasing not only because of the placement of the maturities but because Spain and Italy, as examples, need to borrow ever larger amounts of money to finance themselves as they sink into worsening recessions. Since the ECB apparently is proposing to sterilize their purchases then the money supply will not be expanding and so as the debt load increases the primary funding, the national debt auctions, will have an increasing difficulty finding buyers.
The ECB’s actions also means that their balance sheet will be expanding. The ECB is already at $4 trillion, almost twice the size of the America’s Fed, and it is about grow much larger. This also has consequences. Regardless of market perception, there is no such thing as “Free Money” and the liabilities of the ECB are borne by the various central banks of Europe and by the nations that own them. As the ECB expands its balance sheet “without limit” the credit quality and the risk profile of the various owners of the ECB correspondingly declines. Peter always pays Paul in the real world and the expansion at Europe’s Central Bank is off-set with a deterioration of the national credit quality of the nations so that the entire construct sets itself up for the possibility of being downgraded by the nemeses of Europe, the ratings agencies, because they cannot control them. A “AA” Germany and/or a “AA” Europe Union is quite a different animal than a “AAA” one no matter the rhetoric of Brussels and Berlin.
Conditionality
While everyone stares at Frankfurt and the last ditch effort of Mr. Draghi there have been other events which are part of this play and merit your attention. Austria has come out and stated quite succinctly that no more Austrian money will be used for other countries; any other countries. Yesterday the Netherlands stated in absolute terms that no more of their money will be used for Greece. If the condition of any ECB funding is to be the approval of the EU and the use of their Stabilization Funds then what the Mario Draghi is proposing may never come to pass, may never happen and may just be a rhetorical exercise in wand waving. If the EU refuses to fund Greece, Spain, Italy et al then under the current apparent plan, the ECB would do/could do nothing but sit and flail in the wind. I suppose that the ECB could step-up and buy all of the debt of Europe and declare the nations of Europe a “Debt Free Zone” and perhaps the markets would rally on a $100 trillion ECB but then Germany, being accountable for 22% of the ECB would have a liability of $22 trillion with an economy of $3.55 trillion but the number would never get counted in Europe because it is a contingent liability except that those who fund are not quite that dumb and some have gotten the punch-line earlier than others and are not funding now. The “condition” of all of this promised ECB funding may prevent it being actualized and this seems to be something that almost no one is taking into account.
A Frightening Possibility
To me, the world seems askew at present. China is in serious decline, Europe is in a virtual recession as Eurostat releases the numbers today and points to a -0.2% contraction of the EU-17. The markets rally based upon the supposed three Saviors of the world, the central banks of the United States, Europe and China and so the worse that it gets the larger the rally as the central banks will ease and ease again until some kind of wall is hit. The financial markets rest upon two tenets which are the focus of the market and the perception of those funding. The Great Depression is largely thought to have been sparked by the failure of an Austrian bank. We have watched Dexia, Bankia and several Austrian banks go by the wayside already and so far the markets have ignored the pattern of warning. Spain is going to be forced to the till and if funding is cut off and then if Italy arrives in the same line and various nations refuse to fund then we have arrived at the place where the rock meets the hard place and where hopes and prayers run dry.
Take what solace you may now because it may become hard to find in the not too distant future.
“It is the bright day that brings forth the adder, and that craves wary walking.”-William Shakespeare, Julius Caesar
No comments:
Post a Comment