Temporary Respite: Why ECB’s Tricks Won’t Solve the Crisis

Published on Spiegel Online Ingternational, by staff, January 16, 2012.

Ever since the European Central Bank began flooding the markets with cheap money, European banks have rediscovered their taste for sovereign bonds. But the crisis is far from over, as Standard and Poor’s recent raft of downgrades showed. Some bankers are saying it’s just a matter of time before yields on peripheral bonds shoot up again … //  

… Artificial Demand:

Indeed, the problems are too far-reaching to be solved with a single measure from the bank’s bag of tricks. But for all intents and purposes, the ECB’s new strategy is just that — a trick. By flooding the banks with cheap money, it is artificially generating demand for sovereign bonds. In doing so, it can also cut back on its own bond purchases, which have also been highly controversial within the bank itself.

For the banks, it’s a fantastic deal. They can borrow money from the ECB for three years at the prime interest rate, which currently stands at 1 percent. If they used that money, say, to buy Italian bonds last Friday, they would get the much higher interest rate of 4.83 percent. Then they could turn around and deposit these bonds at the ECB as security, and borrow even more money at 1 percent.

This new ECB strategy would appear to benefit all the major players: the banks, the cash-strapped countries and the ECB itself. But it has also triggered worries that Draghi has merely created a kind of financial perpetual-motion machine. In any case, the strategy does nothing to alter the fact that the institution ultimately bearing the risks is still the ECB — and, with it, the taxpayers.

Since Draghi announced the new program on Dec. 8, 523 banks have taken advantage of the bargain offer to borrow almost €500 billion ($632 billion). However, instead of passing that money on in loans to companies so as to spur the economy, they have redeposited the money with the ECB. Deposits at the ECB — which are regarded as a barometer of the banks’ risk aversion during the crisis — piled up higher and higher every night.

Then, last week, some of the banks dauntlessly used some of their liquidity to purchase Italian and Spanish bonds at the auctions. Overnight deposits at the ECB dropped by almost €15 billion.

Printing Money:

ECB council members are pleased with themselves and their intervention. “The positive reception shows that, with this measure, the ECB has made a very important contribution to improving the banks’ refinancing situation,” says Germany’s Jörg Asmussen, a member of the ECB Executive Board. “In the final analysis, the measure helps re-establish trust between the banks, which also makes it easier to extend loans to the real economy” — and, he could have added, to the crisis-stricken states themselves.

“The markets have thankfully acknowledged the ECB’s action from December and are expecting the central bank to continue to be ready to provide emergency assistance,” says Clemens Fuest, an economics professor at the University of Oxford who advises the German Finance Ministry. In economic terms, he adds, whether the ECB purchases bonds directly, or makes money available to the banks to do so, ultimately amounts to the same thing.

“The ECB is increasingly assuming the role of a provider of public-sector finance and is helping out by printing money,” says Jörg Krämer, chief economist at Commerzbank, Germany’s second-largest bank. In doing so, it is drifting further and further from the role it has classically played and from the traditions of the Bundesbank, Germany’s central bank, whose supreme mandate has always been to guarantee the stability of the currency.

But Draghi has another priority, namely, to rescue the euro. And he will only succeed if he manages to bring lasting calm to the markets — and if the crisis-ridden countries make use of the time his measures buy them to reform their national economies. Still, Krämer sees a problem with this. “If the situation continues to improve,” he says, “it will be hard for many governments to sell the necessary spending cuts to their citizens.”

Wolfgang Reitzle, head of the German gas and engineering giant Linde, also fears that the will to reform might start flagging again. Were that to happen, he believes the burdens borne by Germans would once again increase while their willingness to finance other euro-zone states would decrease. In an interview with SPIEGEL, Reitzle argued in favor of the surprisingly drastic step of Germany leaving the euro zone.

Paused for Reflection: … (full text). l

Links
:

After the downgrades comes the downward spiral, on PressEurop.eu, by Niels Bo Bojesen, January 16, 2012;

Stephen Harper and the Big Oil party of Canada, on RABBLE.ca, by MURRAY DOBBIN, January 16, 2012;

Toronto Area Council: NDP Federal leadership debate, Start: Jan 18 2012 – 8:00pm, End: Jan 18 2012 – 9:00pm. Location: Bloor Collegiate Institute, 1141 Bloor Street West, Toronto, ON, Canada. See Google Map.

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