More deception and half-truths

[John Clark]

Dear all,

I just thought I'd point out the latest deceptions, this time being perpetrated by the ECB (European Central Bank).

Generally, I agree with the ECB's position that it would be wrong and (long-term) very counterproductive for the ECB to "print money" to try and solve this crisis.

However, what the ECB says and what it does (just like many other peak institutions) are two different things.

Firstly, the ECB is openly admitting to more-or-less directly supporting failing European sovereign bonds by purchasing up to around 20 Billion Euros worth PER WEEK. That might not sound like much these days, but it adds up to almost 1 TRILLION Euros worth per year. Also, because so much of the collateral in Europe is dodgy, the ECB has also lowered it's standards on the crappiness of collateral it will accept. So we see that in fact these moves are BIG by any standard. This is not, strictly speaking, "money printing".... but it will turn into that if the sovereign bonds the ECB buys are defaulted on by the issuers - then things would get really ugly. The ECB is crossing it's fingers, toes and hair follicles that it won't come to that.

But the half-truths became more obvious recently with the ECB's creation of the "LTRO" facility discussed here at Macrobusiness.

Under this scheme, the ECB offers essentially unlimited loans of up to 3 years duration to banks, at almost zero interest (those of you with mortgages - don't you wish you were a bank? Hush now, don't rock the boat, you are a pleb and you should know you only get scraps from the masters table). The idea is that the banks will borrow this money and use it to buy the debt of struggling european nations (e.g. Spain, Portugal, Italy), which pay a much higher yield (5% or more).

The banks get to sit in the middle of this transaction and make money off the interest differential. Ahh the wonders of finance!

So on the one hand you get the ECB categorically SAYING that it can not and must not intervene in a large scale in sovereign debt, and yet you have them DOING 1 Trillion Euros worth of exactly that directly through the "front door" and offering banks UNLIMITED funds to help them do it via the "back door" and to line the banks pockets in the process.

As the commenter StanGoodvibes points out in the above Macrobusiness piece (quoting an article from the Telegraph):

If the sovereign debt plunges, the banks will need more support; and the ECB will take on the risk. Open Europe said encouraging the banks to ‘load up on risky sovereign debt just to keep the eurozone ticking over in the short-term’ could amount to a ‘spectacular own goal’ by the ECB.

the ECB’s exposure to the PIIGS has now reached €705bn, up from €444bn in early summer.

And at this rate, as Open Europe says, “it remains unclear how the ECB would cover losses in the event of a sovereign default.”

The ECB can only absorb so many losses before it has to either ask for more capital from member states or print more money – both of which would be politically impossible and damaging to the ECB’s standing.

The ECB is in the thick of this, and they are committed deeply. If the ECB's gamble gets called (via a significant default), the european house of cards will literally implode in dramatic fashion.

I'm not saying it will, more pointing out the consequences will be extreme (to put it mildly).

Also, understand why the ECB and european leaders are so strong about their position on default - they are categorically against it and are doing everything in their power to avoid it. Why? because the system is so awash in debt that a significant default would very likely set off a chain-reaction that would implode the whole house of cards.

I shouldn't need to remind you how high the stakes are here.

It also should be patently clear to my readers that the best possible outcome over the next 5 years (or so) time horizon is grinding recession in many 1st world countries and perhaps tepid growth in a handful of countries (at best). There is no way you can expect, for example, any country in Europe (outside of perhaps Germany) from posting even tepid growth figures when they are straddled with austerity and there is no desire to countenance default.

Bye for now.

John