Tag Archives: european central bank

Today began the next phase of the great monetary experiment, as reality plays a trump card.

Summary: Today began the next phase of the great monetary experiment, the collision of Central Bankers’ bold promises with reality.  History suggests skepticism about the odds of CB’s success (e.g., see the many unbreakable currency pegs and unions which broke). Today the Swiss National Bank folded its cards. Here we discuss the significance of this to them and to us.  This is part one; see tomorrow’s post for the conclusion. (2nd of 2 posts today.)

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Wizard of Oz

Bow before our Monetary Wizards!

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Since the crash, governments of the western nations have conducted the greatest economic experiment ever, with us as the subjects of unprecedented monetary and fiscal stimulus. We have had massive deficits, long periods of zero interest rates (for some now, negative interest rates), and repeated rounds of quantitative easing (in various forms). So far the results have varied by nation from good to great. But as with any experiment, preliminary results often don’t match the final tally. Today we began the next phase.  First here’s some background.

Switzerland’s bold monetary experiment.

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“The minimum exchange rate remains for the foreseeable future the key monetary policy instrument. We’re prepared to buy unlimited amounts of foreign currencies and, if necessary, take further measures …. We will continue to defend the minimum exchange rate with utmost determination …”

— Thomas Jordan, President of the Swiss National Bank, 23 September 2014 — Speech in defense of the 1.20 peg to the Euro set in September 2011.

To keep their exports competitive in September 2011 the Swiss National Bank (SNB) set a minimum exchange rate (a ceiling to the Swiss Franc vs the Euro). In September 2014 President Jordan promised to print unlimited Swiss Francs to defend this level. Some were skeptics, such as the people at Grant’s Interest Rate Observer, 19 September 2014 — Excerpt:

Like a celebrity in flight from the paparazzi, the Swiss Confederation demands protection from its pesky admirers. … The {Swiss franc} is still, for many, the monetary bolt-hole of choice. To the Swiss, whose exports generate 54% of Switzerland’s GDP, it’s a kind of popularity they can live without — indeed, they insist, must live without. So the SNB prints francs.  It drew a monetary line in the sand three years ago: The franc shall not rally through the 1.20-to-the-euro mark, the authorities commanded in September 2011. To enforce this dictum, they bought euros with newly created francs (the cost of production of the home currency being essentially zero).

What to do with the rising euro mountain? Invest it, of course. CFA fashion, the central bankers are diversifying across asset classes and currencies. Among these asset classes are equities, and among these currencies is the dollar. As of June 30, the Swiss managers held $27 billion in 2,533 different U.S. stocks, according to the bank’s latest 13-F report …

Here’s a metaphysical head scratcher. The Europeans conjure euros, which the Swiss buy with their newly materialized francs. The managers exchange the euros for dollars (also produced by taps on a keyboard) and with that scrip buy ownership interests in real businesses. The equities are genuine. The money, legally and practically speaking, is itself real.. But what is its substance? We mean, how is it different from air?

… In these stupendous interventions, the SNB is hardly unique. Nor is it alone as it attempts to undo, through administrative means, the distortions it creates through monetary policy. New “macro- prudential” directives have tightened standards for home-loan amortization schedules, minimum down payments, affordability, bank capital ratios, etc.

Grant’s recommendation:

{W}e venture that the SNB will sooner or later be forced to permit the franc to appreciate and thus to enrich the holders of low-priced, three-year call options on the Swiss/euro exchange rate. It’s a long shot, to be sure — the options are cheap for a reason — but we judge that the prospective reward is worth the obvious risk.

Four months later their recommendation paid off — big. Bloomberg describes the fireworks:

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Update on Europe: Tinker Bell fails to deliver

Summary: Monday’s post explained why last week’s statement by ECB President Mario Draghi was not the game-changer Wall Street assumed. Today the ECB met and did little but give more comforting words. Here’s the scoop.

Sorry I disappointed you

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The ECB President Speaks to the world

Cutting through the blather, here is my guess what was in Mario Draghi’s notes for the press conference:

  1. Lead off with: no change in rates or policies.
  2. To periphery: pay your debts, slackers!
  3. To euro-governments: continue flogging austerity & reform until morale improves!
  4. To everyone, most especially myself: The euro is irreversible.
  5. About the future: in coming weeks we’ll think about doing stuff.
  6. Don’t worry: if conditions go into the toilet again, we’ll do stuff.
  7. What about my speech last week?  The euro is irreversible!
  8. What will stop the long slide of Europe into recession or worse? Austerity & reform!
  9. Why will those things work in the future since they have not so far? The euro is irreversible!

Excerpt from Draghi’s statement

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Last week they spoke comforting words, but I saw only the frightening aspects of the euro-crisis

Summary:  Although entertaining as gallows humor, last week’s statement by ECB President Mario Draghi illustrates important but seldom discussed aspects of the euro-crisis. Here we read and annotate the text.

It’s an oddity of our time that people tend to rely on secondary sources — journalists and pundits — to learn what the world’s leaders say.  Twenty years ago major papers, such as the New York Times, ran their speeches in full. Thanks to the Internet we can do so as well.  Here we feature a major speech, with some information and analysis accompanying it to provide context.

The EU’s preferred policy solution

Contents

  1. An annotated speech by the President of the ECB
  2. They know what they want. They don’t see why their actions almost guarantee failure.
  3. They are relying on hope
  4. Other posts reporting Europe’s slow march to the cliff

(1) An annotated speech by the President of the ECB

In our world few things are as they seem to be. There are hidden complexities. There are hidden truths. There are lies and misrepresentations. Here we examine this important speech by a high European official, a speech which has electrified not just Europe, but investors around the world (mostly for wrong reasons). Draghi speaks candidly. But to correctly interpret his words we must understand his orientation — described in the annotations.

Speech by Mario Draghi, President of the European Central Bank at the Global Investment Conference in London 26 July 2012

… I think the best thing I could do   is to give you a candid assessment of how we view the euro situation from Frankfurt. And the first thing that came to mind was something that people said many years ago and then stopped saying it: The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does.

He refers to the widespread forecasts at its beginning by economists that the euro-system could not and would not work. For details see Can the European Monetary Union survive the next recession?, 11 July 2008. Next he explains the results to date of the euro experiment:

So the euro was a bumblebee that flew very well for several years. And now – and I think people ask “how come?” – probably there was something in the atmosphere, in the air, that made the bumblebee fly. Now something must have changed in the air, and we know what after the financial crisis.

Paul Krugman gives a more accurate explanation:

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The Fate of Europe has become visible. Only how and when the break comes remains uncertain.

Summary:   The last act of the EMU’s death throes has begun. We already knew the two possible endings: further unification or fragmentation.  Now we can see far enough to guess about when and how it will end.  Probably in a crisis, in which the odds of policy errors will be high — and the odds of unification are low.

“It is a national and imperative need to officially ask our partners in the EU for the activation of the support mechanism we jointly created.”
— Prime Minister George Papandreou, requesting a 45 billion euro loan from the Troika (EU, the European Central Bank, and the International Monetary Fund), 23 April 2010

A dream, perhaps soon to be real

Contents

  1. Summary of the Euro-crisis
  2. What will resolve the situation?
  3. What about the magic of Central Bank action?
  4. For more information

(1)  Summary of the Euro-crisis

Those words of Prime Minister Papandreous marked the beginning of the end for the European Monetary Union.  Now, two years later, it enters what looks like its final stage.  Here are forecasts about the next steps.  We cannot see the ending, but unification or fragmentation seem likely alternatives.  The current system is dying.

The European Economic and Monetary Union (EMU) was born on 1 January 1999 as a bold attempt to unify Europe by monetary policy as an intermediate step between a loose confederation and full political union.  Many experts said it would fail (see here for details).

The 2008 – 2009 crash exacerbated imbalances that had accumulated from the EMU’s flawed design (for details see the articles at the end of this post).  Each stage of the EMU’s death throes was a crisis, met by measures that were slow, late, incremental, and too small.  Each crisis larger than the previous in both euros and territory.

Each response was  known to be inadequate when made (despite the giddy applause greeting each new package).  Nothing more was possible. The leaders of the EU, ECB, and IMF — like ours — operate within narrow ranges of freedom.  Bold actions work only when a nation’s leaders and people will support them.  Europe’s elites and peoples want two incompatible things.

  • They want unification (to avoid war and control their destiny in a world of giants).
  • They don’t want what goes with it — the transfer payments (eg, as California taxes go to spending in Mississippi & New Mexico), the central control of spending (ie, by Germany), and the need to get along with one another.

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The periphery of Europe – a flashpoint to the global economy

Introduction:  This is the fourth in a series of dashed off speculative opinions.  Normal procedure on the FM website for these topics would be 3 thousand word posts, supported by dozens of links.  I dont’ have the time to finish them, and too many of these outlines have accumulated in my drafts file.  Perhaps these will spark useful debate and research among this site’s readers. 

In this third year of recession of the worst recession since the 1930s, reserves are depleted around the world.  Cash reserves of households, businesses, and governments.  This increases our susceptibility to a shock.  A poor bio-metaphor to this is the poor health of the world’s peoples in 1918.   The global economy remains unstable, as it was in 1929.  Many links in the world’s economic machinery have broken.  Although the global economy might be in recovery, the stress remains great.  Another link might snap at any moment, increasing the stress on the remaining links — some of which might in turn also snap.  Since the data is conflicting (as usual during times of large change), we don’t know how close they (or us) are to the edge.  Central Bankers know this, which is why they keep the petal to the metal while talking about exit strategies.

 One of the most dangerous flashpoints is Europe’s periphery (the USA is another).  Iceland, Ireland, Portugal, Spain, Italy, Greece, Eastern Europe up to the Baltics.   The european economy is highly integrated, and collapse in even a peripheral nation might ripple though the region with unpleasant consequences.  So rescue efforts are under weigh by the EU and IMF.  But the people of one of more of the crippled nations will certainly reject the prescribed austerity measures.  Greece is first in line, and general strikes are already being planned.  Red emphasis added.

George Magnus, a senior economist at UBS, comments on these developments in “The Return of Political Economy”, 3 February 2010 — A terrifying analysis expressed in mild words.  Excerpt:

In the Euro Area, the politics are complex. Politically, the chances of some of the sovereign invalids being able to implement required fiscal restraints are small. In others, the changes of doing so over a protracted period without social unrest are questionable. However, politically, nothing short of the integrity of the Euro and the Euro Area are at stake. For this very reason, the issue will probably not come to had in the immediate future, or for some time, because all Euro Area countries have strong vested interests in foreign a path back to stability as quickly as possible, and all the more so since contagion has spread to Portugal and Spain. But what will this need?

Austerity packages never work in a vacuum. One of more of 4 crucial ingredients have to comprise the setting.  These are…

  • currency debasement,
  • a sharp fall in interest rates,
  • monetization of debt, and
  • a bail-out financing package.

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