Last week the ECB released a press statement declaring its commitment to back the EuroZone debt with potentially infinite monetary assistance for up to three years. It says:
No ex ante quantitative limits are set on the size of Outright Monetary Transactions.
In simpler words, it shall, if necessary, print more money and buy the sovereign bonds of these countries that mature between one and three years.
But there are conditions for this assistance. The recipient countries must stick to the “macroeconomic adjustment programme” –in other words Brussels gets to dictate how these countries run their economies.
The markets cheered –the Euro appreciated, EU borrowing costs plummeted, and the banking sector globally saw a share rally. When Ms. Merkel said roughly the same thing they didn’t. And there is a sound reason to explain that difference. Germany, for all its economic weight in the EuroZone pie, cannot print more money and buy bonds indefinitely. The ECB on the other hand can.
But I think it does not make a real difference. And here are three major reasons why:
1. The Franco-German austerity measures have just assumed a different name –the “macroeconomic adjustment programme“. A foreign creditor still gets to say what a debtor country can do or should do. Many EuroZone countries had a problem with the first form and will definitely have a problem with the second form. The voters in those countries won’t care who tells their country to shut down a school –to them it is the same thing. And hence, the governments of these debtor countries will still be under immense pressure to adjust their macroeconomy.
2. The ECB’s firepower, despite what the ECB says, is not infinite. It is limited although not in the same way as Germany’s. When the ECB prints all that money to buy those bonds it will stoke inflation –at least in the short term. One of ECB’s mandate is to check the EuroZone inflation. Surely it cannot go on printing money forever. Even if it does, more money will simply mean that other creditors will want to buy bonds of other EuroZone countries (that are not receiving the said assistance and are probably doing great on their own) at a lower price –to account for this inflation risk –thereby increasing the borrowing cost for the entire Eurozone. And even if no one else buys those bonds we will anyway see the single currency fall in the international markets if inflation rises.
As I have previously argued, inflation is not a risk if these countries produce the matching wealth to those bonds. It therefore appears that either the ECB is under pressure to calm the markets in the short term or it has a well placed confidence in the ability of other EuroZone countries to generate that wealth using the integrated single market.
3. The moral hazard factor is still there. The ECB plan is to print more money and buy the bonds of countries that are struggling. As I argued in point 2, this plan relies on the success of at least some EuroZone countries (including perhaps even the struggling countries) to generate that wealth. This can, and I think will, be seen as redistributing the money. True enough this problem lies with all large sized economies –some poor states in India/U.S. for example receive central assistance at the expense of richer states. But whereas India or U.S. very rarely discussed separation the EU is currently discussing it and has been discussing it for a while. The risk of this factor becoming a deterrent to the ECB’s efforts will be visible in the upcoming elections in the Netherlands and Germany.
The ECB has definitely made a strong commitment to save the Euro. Sometimes all one needs is a nuclear deterrent. Perhaps it won’t come to using its nuclear option of printing more money. The current holders of the EuroZone bonds may see this deterrent as a safeguard and hold on to these bonds. It is all about perception anyways.
But all this rests precariously on the factors I have enumerated above. A small sell movement by someone who acts on these factors could increase the perception of the markets that perhaps the nukes will be launched. That can turn that small sell movement into a big one and bring us back to square one. And that is why I think this plan is insufficient and mainly a political move by the ECB (in light of perhaps the German economic slowdown).