Irrational Draghi Exuberance
Irrational Draghi Exuberance
by Stephen Lendman
Thursday was Draghi day. He explained what ECB watchers knew. At his Frankfort press conference, he said Governing Council members agreed to unlimited bond buying. It's called Outright Monetary Transactions (OMT).
Bundesbank President Jens Weidmann alone dissented. He called Draghi's plan "tantamount to financing governments by printing banknotes." Doing so creates more problems than solutions.
In late August, Weidmann said bond purchases were "too close to state financial via the money press for me. The central bank cannot fundamentally solve the problems this way. It runs the risk of creating new problems."
OMT will target government bonds with one - three year maturities. Longer-dated debt with residual maturities of that duration will be included. Purchases ostensibly will be sterilized to keep money supply neutral. Don't bet on it. Earlier ECB promises fell short.
Draghi hopes to contain borrowing costs. Expect short-term success only. At best he'll buy time. Since crisis conditions emerged in fall 2007, every plan tried failed. They bought time, but little else.
Is this time different? Don't bet on it. More on that below.
Draghi's plan involves conditionality. One analyst calls it "Eurocrat-speak for debtor countries to agree to wear the particular austerity hair shirt we have designed for them before they get any dough."
Countries needing help must request it. Spain and Italy haven't asked. Rome wants Madrid to go first. Spain wants some conditions waived. They involve strict austerity. Doing so assures greater trouble, not less.
ECB rules prohibit direct state financing. As a result, secondary market purchases are planned.
ECB's preferred creditor status was waived. Doing so removes the requirement for central bank repayments ahead of private ones.
Draghi's plan solves nothing. He kicked the can down the road. He left many questions unanswered. One analyst called his scheme fantasy land. A chasm remains between promise and fulfillment. The ECB is notoriously unsuccessful in soaking up excess liquidity. Keeping inflation in check won't be easy.
Deep-seated problems are worsening. Bond-buying can't substitute for sound policies. Markets Thursday paid no attention.
Short-term fixes mean higher valuations. Push eventually comes to shove. Reckoning day can be delayed but not denied.
The ECB's earlier Securities Market Program (SMP) failed. Citibank strategist Jamie Seale believes OMT won't fare better. He called it dangerous. Will it do anything more than buy short-term relief? It's no solution, he stressed. "The economic backdrop remains dire."
SMP initially sent peripheral nations' sovereign yields lower. Doing so didn't last long. Moreover, Draghi may intend to let rhetoric more than policy do most heavy lifting. Unfulfilled promises only work for so long.
Goldman Sachs also dissed him. It called OMT SMP 2.0. It said no easy way out of crisis conditions exists. An ECB declaration about being pari passu leaves unanswered questions relating to voluntary debt restructuring. It also provides no assurance about sound policy measures following promises. Why now when not earlier.
Bank of America economist Laurence Boone doubts OMT's success. Draghi's plan is more negative than positive. Conditionality was tougher than expected.
The IMF's role as monitor means Big Brother is watching. These factors lessen the likelihood that troubled countries will seek help or as much as they might have otherwise.
Draghi announced no yield targets, no bond purchases ex-ante transparency, and no technical details on how OMT differs from SMP.
Ireland and Portugal won't qualify for help until they regain market access. Greece is too far gone to help.
Peripheral banks aren't provided relief. Other reservations were raised. JPMorgan Asset Management's Michael Cembalest said Draghi may have to engineer a massive debt restructuring and take huge losses. In a note to clients, he explained:
"Europe is conducting one of the most unorthodox experiments of the last 100 years (a competitiveness adjustment mostly through wage and price declines instead of currency devaluation), and they are making it up as they go."
Euro countries face problems that won't quit. Peripheral nations are deeply troubled. Massive capital outflows hammer them. Southern Europe is experiencing the greatest amount "the modern world may have ever seen."
Cembalest's bottom line is that Draghi may be in way over his head. He's holding on to "trillions in loans and bonds that the private sector won't want to own unless there is a miraculous rebound in growth and employment." It's nowhere in sight.
He dubbed the ECB the "European Creosote Bank." He can't explain what he means except to say it relates to a fictional character eating "several plates of mussels, pate de foie gras, beluga caviar, eggs benedict, leek tarts, frogs' legs," and other assorted delicacies washed down with bottles of expensive wines, champagne and ale. The result isn't pretty.
Other analysts call Draghi's plan short-term relief at best. It's a financial equivalent of France's Maginot line. It's vulnerability is clear. Outflanking it is likely.
Troubled banks need restructuring. Peripheral economies need massive amounts of help. Perhaps it's beyond what's possible to provide.
Instead of addressing problems responsibly, Draghi and political leaders opt for punishing austerity, rising unemployment, lower investment and consumption, deeper recession, and eventually a Eurozone breakup.
Phoenix Capital Research's Graham Summers calls the EU beyond saving. Its banking system is 36 trillion euros in size. Its deposits are 15 trillion euros.
Germany hasn't enough resources to backstop troubled countries. "No one does. The money simply does not exist." Too much is needed. If Draghi oversteps, Germany will exist the Eurozone and go it alone. It's very concerned about future inflation.
New plans, other strategies and promises together comprise "one big distraction." Draghi and other central bankers are fast losing their grip on things. They'll never say so publicly, but privately they're worried for good reason.
Progressive Radio News Hour regular Jack Rasmus warns regularly about trouble on air. ECB policies have had "virtually no impact" on Eurozone economies or their "drift into recession."
Since spring 2012, "signs and indicators suggest the European banking system is" increasingly unstable. Most obvious is the need to bail out Spanish banks. They're in serious trouble. Amounts committed fall far short of what's needed.
Sovereign Spain and its troubled regions need massive amounts of help. Spanish bailout costs alone exceed ECB's capacity to help. Northern country banks are hoarding cash. Capital flight from peripheral countries is usually "the canary in the coal mine." It signals much greater trouble coming.
Draghi said inter-bank lending is dysfunctional. It's not working. "When inter-bank lending shuts down," says Rasmus, "bank to non-bank business and bank to consumer lending quickly declines." Recession is further exacerbated.
In 2007-08, it happened. History is now repeating. Rasmus believes the Libor scandal may be this year's subprime mortgage debacle equivalent. It may trigger the next banking crisis. How things play out remain to be seen. The immediate effect is declining confidence in banks and how they do business.
"The key transmission mechanism between the banking crisis and spreading European recession is bank lending contraction: banks to other banks, banks to governments, and banks to non-bank businesses and consumer households."
As lending erodes, so do economies. Forced austerity exacerbates crisis conditions. Growing evidence shows troubled EU economies. Greece and Spain are in "bona fide depressions," says Rasmus.
In early 2012, Britain entered double dip territory. France is declining. German services collapsed. The nation's composite index was a negative 46.3 read. So is its export engine and domestic demand. Throughout Europe, manufacturing contracted.
Business and consumer confidence are sinking. Investment is down. So are government revenues. Unemployment is rising. Less household income and lower consumption follow. Sovereign debt levels rise. So does instability compounded by more austerity.
Policy makers know everything tried so far failed. Instead of addressing crisis conditions responsibly, they keep kicking the can down the road.
They're also packaging old wine in new bottles. They hope earlier failures will magically succeed this time. Don't bet on it.
Stephen Lendman lives in Chicago and can be reached at email@example.com.
His new book is titled "How Wall Street Fleeces America: Privatized Banking, Government Collusion and Class War"
Visit his blog site at sjlendman.blogspot.com and listen to cutting-edge discussions with distinguished guests on the Progressive Radio News Hour on the Progressive Radio Network Thursdays at 10AM US Central time and Saturdays and Sundays at noon. All programs are archived for easy listening.