The European
Central Bank's latest maneuvers jettison limits to the expansion of its balance
sheet. The ECB's manner of improvisation is reminiscent of Federal Reserve
Chairman Ben S. Bernanke's dismissal of legal restrictions in 2008, when
Bernanke talked his way around the law before pliant, ignorant, and frightened
politicians.
European Central Bank President Mario Draghi's
abandonment of monetary restrictions would be, in due time, an
incitement to unlimited price inflation. This is also true for the United
States. However, practical matters (discussed below) will restrict this central
bankers' nirvana. After watching how swiftly opposition to the ECB's latest
decrees melted away, Ben Bernanke may feel reassurance of his freedom to roam.
However, he too can only go so far. Maybe he'll be stoned to death.
So, buy gold, silver, and gold and silver stocks.
It was not just Alan Greenspan. Now, central bankers
the world round draw greater devotion than Britney Spears (who, according to Forbes
magazine's 2012 rating, is the world's sixth most powerful celebrity,
demonstrating once again that no matter how egregiously these mystical
abstractions behave, they can do no wrong). On September 6, 2012, "Mario
Draghi's press conference was covered as if it were a soccer match. We are told
that all across Europe shop stalls and bistros had TVs showing his
presentation," reported Art Cashin at UBS. (Cashin's Comments,
September 7, 2012). Comparisons with the waning of the middle ages are apt.
The European Central Bank president, wearing an "immaculately tailored
dark suit," delivered an address that left no doubt he will do whatever it
takes to preserve the euro. "I am what I am," Draghi warned his
Frankfurt audience, which was sitting (and possibly shaking) within a stone's
throw of the Bundesbank.
Draghi's announced a new acronym OMT, (Outright Monetary Transactions).
Henceforth, the ECB will buy unlimited quantities of "sovereign
bonds in the euro area." In the not-too-distant future, the betting line
here is an expansion beyond sovereign bonds, to suit an unknown (as this is
written) but a greater crisis. Draghi's declarations on September 6 addressed
the current meltdown of falling European sovereign bond prices - particularly
those issued by Spain and Italy. Yields are rising and buyers at auctions are
disappearing, so the ECB will buy and hold yields below an unstated ceiling.
This objective is clearly outside the ECB's sole mandate to maintain price
stability. Draghi's description of how his actions are consistent with the
ECB's function is a monument to bureaucratic malfeasance. His rationale of the
compatibility between unlimited money printing and price stability was
explained in a three-step syllogism: [Step 1:] "We aim to preserve the
singleness of our monetary policy and to ensure the proper transmission of our
policy stance." [Step 2:] "OMTs 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." [Step 3:] "Hence, 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." [My italics. -
FJS] If the Greeks were in a surplus position, they might tutor Draghi on his
misconstruction of logic.
Draghi let his audience know there will be no
expansion of the money supply. If this is so, inflationary tendencies from his
newest initiatives will be second-order consequences. The press release from
the ECB that accompanied Draghi's speech states: "STERILIZATION: The
liquidity created through Outright Monetary Transactions will be
sterilized." That is the full statement. The ECB established an airtight
condition: For every sovereign bond the ECB takes in-house, it will sell a bond
of equal price.
This being true, the ECB's buying operations are not
unlimited. But hark! Draghi squirmed out. The September 7, 2012, Grant's
Interest Rate Observer reports Draghi told euro zone officials if the debt
matures within three years, it does not "constitute the act of monetarily
financing a government."
The importance here is not so much the specific ukase,
but that by Draghi stating such, it is so. Flipping through October 2008
archives is a reminder of expedient decrees in the United States. In the here
and now, the ECB can do what it wants on the fly: so watch out. For instance,
no private bondholder - pension fund, insurance company, hedge fund - should
accept Draghi's word that it holds equal footing with the ECB in a sovereign
workout.
Back to the specific "three-year rule," it
is a short step for the ECB to declare (since the purchase of these particular
sovereign bonds does not constitute the purchase of a sovereign bond) the
requirement to sterilize Outright Monetary Transactions of three-and-under
bonds does not apply. And, even if the ECB attempts to live by its promise of
sterilization, the poor quality of its balance sheet will restrict such
operations. There will be no buyers for the unspeakable trash it is hiding.
At the press conference, Draghi once again loosened
the ECB's requirements of what constitutes acceptable collateral. At this
stage, it would be more helpful to produce a summary of what is not acceptable:
a very short or non-existent list. Here lies the greatest problem of all, that
of trust. European banks already restrict their overnight lending to the ECB.
If they decide the solvency of the European Central Bank is untrustworthy, the
ECB, Fed, Bank of England, and Swiss National Bank may fall like toy ducks in a
shooting gallery.
In any event, Mario Draghi has put the ECB in a
position of no return. He must now "do whatever it takes," meaning
engage in "unlimited" purchases, or he, and the euro, will lose all
credibility. In 1957, Federal Reserve Chairman William McChesney Martin found
himself in the same position. The U.S. Senate lobbied the Federal Reserve to
cap interest rates. Should it accept the mission, Martin's Fed would buy U.S.
Treasury bonds with newly created Federal Reserve notes and institute a ceiling
on rates. Martin knew better. He told the U.S. Senate Committee on Finance, on
August 13, 1957:
"It
has been suggested, from time to time, that the Federal Reserve System could
relieve current pressures in money and capital markets without, at the same time,
contributing to inflationary pressures. These suggestions usually involve
Federal Reserve support of the Unites States Government securities market
through one form or another of pegging operations. There is no way for the
Federal Reserve System to peg the price of Government bonds at any given level
unless it stands ready to buy all of the bonds offered to it at that price.
This process inevitably provides additional funds for the banking system,
permits the expansion of loans and investments and a comparable increase in the
money supply - a process sometimes referred to as monetization of the public
debt. This amount of inflationary force generated by such a policy depends to
some extent upon the demand pressures in the market at the time. It would be
dangerously inflationary under conditions that prevail today. In the present
circumstances the Reserve System could not peg the government securities
without, at the same time, igniting explosive inflationary fuel."
Martin was unschooled in economics. He made it through
life with only a baccalaureate degree, in English and Latin.
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