Over the last five years, market participants have largely operated based on the “Bernanke Put” (the belief that no matter what happens Bernanke will somehow save us).
However, the ECB’s Mario Draghi may have surpassed the Bernanke Put as the biggest bluff in financial history last year with his claim that the ECB will take action and that the action will “be enough” to solve the EU Crisis.
Let’s consider what the ECB has done so far and whether or not it has worked.
To date, the ECB has:
- Intervened in the sovereign bond markets throughout 2011.
- Launched its LTRO 1 and LTRO 2 schemes which provided over €1 trillion in funds to EU banks.
- Opened up various liquidity windows to EU banks.
- Facilitated bailouts of Greece (2) Portugal (1) Spain (1) Ireland (1) and soon to be Cyprus and Slovenia.
- Ballooned its balance sheet to over €3 trillion Euros (roughly 30% bigger than the German economy, which is the largest single economy in Europe).
Has the EU Crisis been solved by any of these measures? The obvious answer is no. The EU Crisis began in earnest in January 2010 with Greece. Today, August 2012, Greece is still an issue and is in fact about to default or leave the EU.
So, one has to ask one’s self… if the ECB (along with the IMF and Germany) has thus far failed to manage, let alone solve, Greece’s problems (a country which comprises only 2% of EU GDP and whose bond market was just €350 billion), how is it now going to solve those of Greece, Spain, Ireland, Portugal, Cyprus, and Slovenia all at once?
The answer is obvious: it cannot. Draghi is bluffing
However, for the sake of argument and since I’ve received so many emails claiming that the ECB has everything under control, let’s consider the ECB’s options. I can think of just two potential “Hail Mary” moves the ECB could stage to attempt to stop the Crisis. They are:
- Massive money printing and buying of sovereign debt
- The issuance of Euro-bonds along with across the board banking backstops
Let’s say the ECB opts for #1. First of all, rampant monetization would weaken the Euro dramatically: something I’m not sure the ECB wants to do given that the currency is already on the edge of a cliff.
Secondly, this policy would almost certainly result in Germany threatening to, if not outright leaving the Euro. We’ve already seen multiple German officials leave the ECB based on its monetary profligacy. Moreover, Germany knows all too well how monetization of debts pans out: Weimar. According to a recent poll, 69% of Germans are worried about inflation. Do you think they’d let Merkel permit the ECB to go on a money-printing rampage?
So the next time someone tells you that the ECB can just hit “print” and monetize sovereign bonds to control the EU Crisis, show them these charts and ask them to explain how this time would be different. The ECB has been monetizing bonds ever since 2010. It has not only failed to control the sovereign debt crisis for any individual country, but it has failed to stop the sovereign debt crisis from spreading to larger countries.
Now let’s consider the ECB’s second “Hail Mary” option: the issuance of Euro-bonds and across the board backstopping of EU banking deposits.
For starters, Angela Merkel has said that there will not be Euro-bonds for “as long as [she] live[s].” This is not a bluff. The issuance of Euro-bonds goes against the German constitution. If Merkel were to even consider this option she would likely be kicked out of office (remember she’s up for re-election next year).
This would also result in Germany losing its AAA credit status. Germany is already approaching the dreaded Debt to GDP level of 90%. And thanks to nearly €1 trillion in back-door bailouts to Europe, the country is already on the hook for potentially tens if not hundreds of billions of Euros worth of losses: money Germany doesn’t have.
As for backstopping EU deposits… no entity on earth has the capital to do this. Total Eurozone deposits stand at €15 trillion. Even deposits at the current EU “problem” countries (Spain, Italy, Portugal and Ireland) are €5.5 trillion. That’s nearly TWO TIMES the size of the ECB’s balance sheet and over FOUR TIMES the size of the various EU bailout funds (the EFSF and ESM, the former of which only has €65 billion in capital left by the way).
Again, in very plain terms, NO ENTITY on planet earth has the money needed to backstop banking deposits for the PIIGS, let alone the entire EU. So scratch that idea off the list.
The above is not opinion or idle conjecture; these are all verifiable facts, which is why I believe Mario Draghi is bluffing when he says the ECB can act and that its actions be “enough.”
Indeed, as a merely philosophical inquiry, ask yourself, when has a Central Banker said “believe me,” and proven to be correct about anything in the last five years?
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Thank you for reading!