Thursday, September 6, 2012

The ECB Hasn't Fixed Anything With Its Latest Scheme

Once again we have a deus ex machina announcement that all is fixed in Europe, nothing to see here, please move along.  Markets are soaring (for today) as again people don't want to actually look at the details of what has actually been announced or think about what is likely to happen.  They hear that the ECB is going to make unlimited purchases of peripheral bonds on an as-needed basis and just hit the "buy" button.  But let's look at some of the details shall we?  Check out this passage from the ECB announcement:

A necessary condition for Outright Monetary Transactions is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme.

The Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme.

Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate.

Basically any country that is to have the ECB buy its bonds will have to give up a good chunk of its fiscal sovereignty to European bureaucrats and then stick by that program or have the ECB cut them off.  As we've seen with Greece, this program can be pretty onerous and may involve massive hikes in taxes which can cause a country's economy to spiral downward.  Here are some of the taxes that were to be raised as part of the austerity program forced upon Greece by Europe:

  • Taxes will increase by 2.32bn euros this year, with additional taxes of 3.38bn euros in 2012, 152m euros in 2013 and 699m euros in 2014.
  • A solidarity levy of between 1% and 5% of income will be levied on households to raise 1.38bn euros.
  • The tax-free threshold for income tax will be lowered from 12,000 to 8,000 euros.
  • There will be higher property taxes
  • VAT rates are to rise: the 19% rate will increase to 23%, 11% becomes 13%, and 5.5% will increase to 6.5%.
  • The VAT rate for restaurants and bars will rise to 23% from 13%.
  • Luxury levies will be introduced on yachts, pools and cars.
  • Some tax exemptions will be scrapped
  • Excise taxes on fuel, cigarettes and alcohol will rise by one third.
  • Special levies on profitable firms, high-value properties and people with high incomes will be introduced.
The result of such massive tax hikes aren't surprising with the Greek economy doing much worse than previously suspected and unemployment skyrocketing to 24.4%.  And after all that hardship, Greece is one month away from possibly being cut off by Europe.

Based on the Greek example, submitting to European oversight of your budget could be a surefire way to flush your economy and your people down the toilet.  I would expect major debate in any country considering going that rout.  Some may simply decide to leave the Euro as the Greeks should probably have done. 

Now on to another important detail in the ECB's statement:

The liquidity created through Outright Monetary Transactions will be fully sterilised.

What this means is that if the ECB makes $100 billion in bond purchases it will also sell $100 billion off its balance sheet to make sure it won't be printing any money.  On a Europe wide basis this action will have zero stimulative impact.  Whatever the ECB giveth to Southern European countries they are going to be taking away from Northern European countries who will likely be facing somewhat higher interest rates as a result.  Budgets in the North will now have a double whammy of having to fund the ESM/EFSF bailouts but also have to pay more interest on their own debt as a result.  At some point these governments are going to no longer want to do this anymore.

In fact, there are already signs that Germany, who is expected to fund much of this bailout is balking.  Check out this statement from the Bundesbank:

In the most recent discussions, as before, Bundesbank President Jens Weidmann reiterated his frequently substantiated critical stance towards the purchase of government bonds by the Eurosystem.

He regards such purchases as being tantamount to financing governments by printing banknotes. Monetary policy risks being subjugated to fiscal policy. The intervention purchases must not be permitted to jeopardise the capability of monetary policy to safeguard price stability in the euro area.


The announced interventions in the government bond market carry the additional danger that the central bank may ultimately redistribute considerable risks among various countries' taxpayers. Such risk-sharing, however, can be legitimately authorised solely by democratically elected parliaments and governments.

And let's not forget that in less than a week the German government may get an "out" from all these bailouts its been forced into.  On September 12th, the German Constitutional Court will rule on the constitutionality of the ESM bailout.  Merkel and the Bundesbank will now have a great excuse not to cooperate with the bailouts any further, it would be unconstitutional.  Even if the court doesn't strike the whole thing down, it is likely to put conditions on Germany's participation, some of which may become onerous.

Also, on the very same day, the Netherlands is going to have a general election which will likely result in a governing coalition that rules by a thread.  It's possible that they will also start balking at providing any more money for these endeavors to bailout irresponsible nations.

This "bailout" may have actually just increased the incentive for all parties to just quit the Euro, the exact opposite of what they have set out to do.  The sterilization is making the bailout even more expensive for the North while the conditionality makes it more expensive for the South.

Things are going to get pretty interesting across the pond.

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