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On Mario's Shock and Awe
Mario Draghi has achieved the impossible. A recap of yesterday's momentous developments:
- Mario was able to maintain "Radio-Silence" on the key elements of the plan he unfolded. As a result, he achieved tactical advantage when he unveiled his bold proposals. The global capital markets were both shocked and awed, and responded with unbridled enthusiasm.
- Draghi has presented a well thought out proposal. It addressed all of the issues that the markets and politicians were worrying about:
A) To appease the concerns of the citizens of Germany, Netherlands, Finland etc. the ECB support plan has stiff conditionality. This important step will, no doubt, assuage any concerns those citizens may have that their tax dollars might be at risk.
B) Mario was decisive. He did not fire a bazooka, he did not fire a howitzer. He fired the most powerful weapon known to a Central Banker. He said the "U" word. Unlimited market intervention was promised. With this one word, Draghi has eliminated any uncertainty on the outcome of the Euro and the EU.
C) Draghi boldly addressed the issue of subordination that has vexed the EU bond markets. The issue no longer exists. All sovereign bonds outstanding will now be treated the same in the event of default. There will be no "preference" provided to the bonds Draghi will buy in the market. Clearly, Mr. Draghi's prior experience with Goldman Sachs has paid off. His knowledge of the capital markets, and the "creativity" that comes from being an ex. Goldman banker, has given him the insight needed to eliminate the subordination issue.
D) Mario changed collateral requirements that will unglue the EU funding markets.
E) In a brilliant move, Draghi placated those old curmudgeons at the Bundesbank who have expressed concern on the inflationary front. Any bond purchases that the ECB makes, will be immediately sterilized. This single step eliminates the possibility of any inflationary consequences.
F) Taken together, the measures initiated by Draghi will allow the ECB to fulfill its promise of eliminating any impediments for monetary policy to be successfully "transmitted" to both Italy and Spain. The low interest rates in Germany will now be available to the citizens of the EU southern countries. The cheap money will fuel a broad based economic recovery.
So, do you like that rundown? That is the way the Draghi presentation is being spun by the media. More importantly, that is the way the market is "reading" the ECB actions. I think it is a complete crock-of-shit.
First off is the fact that absolutely nothing new was announced yesterday. What has been cobbled together by Super Mario is a rehash of of the SMP. Second, is that every detail of the new ECB steps was deliberately leaked to the market before Mario took the stage. How could a program that contains nothing new and and was previously disclosed, have had such a significant consequence to the capital markets? I don't get it.
A - Yes, there is conditionality to bond purchases. The condition for Spain to get support from the ECB is simple. All they have to do is get down on their knees and and beg. To get the bond market support, they will have to accept the austerity measures that Germany requires. The same measures that are now hated in Athens. It gets worse. Not only would Spain have to accept the austerity conditions from the north, the will be obligated to sign up for a full IMF bailout program.
Folks, this will not happen easily. Spaniards do not want Troika types running their government. They definitely do not want the IMF involved. There will be enormous blow-back in Spain to the draconian steps that will be demanded by the IMF. But that is nothing compared with the outrage that will happen in Italy.
B - Yes, Draghi did say the Unlimited word. And yes, that is important. The German citizens should be crapping in their pants over this. Unlimited means unlimited. Draghi can't back off on this promise, ever. He has dug himself a hole that is measured in the Trillions with this commitment. How can anyone promise "unlimited" action when there are always limits?
There will come a day when Draghi will be tested on his promise. There are two possible outcomes. (1) he lives up to his promise and the ECB absorbs a huge portion of the debts of Italy and Spain or (2) Mario blinks at the critical time, and backs off. Either way, that would be the end of the Euro system.
When Draghi said unlimited he bought the EU some time, but he made an all in bet. The consequences of an EU member leaving has now been raised dramatically. Mario has created an "all or nothing" scenario for the EU. When a member leaves, it will crash the entire system. Systemic risk in Europe has increased as a result of Marios' efforts. I don't think the markets (or the politicians) realize how high the stakes have become.
One further note on the "unlimited" issue. Mario clearly said that there is a big "but" to his promise. The obligation to purchase an unlimited amount of debt is conditional on the country involved meeting the "targets" that will be set by a Troika. We have never seen a country live up to the demands of the Troika yet. There is no reason to believe it will happen in the future. What this means is that when things really get tough in Spain, and they are unable to achieve the level of austerity demanded by the North, the ECB will stop its purchases. At that point the entire system will go up in flames. If bondholders believe that this will all work out, they will be disappointed. The bondholders that I know are not stupid. They will see through this obvious flaw.
C - I flat out don't believe Draghi when he says that any bonds purchased will become parri-passu (equal). He can say what he likes, but when the rubber meets the road, and there is a sovereign default, the restructuring will be done by by Brussels. When that happens (it will), the bond holdings of the ECB will be carved out. Private sector creditors will not be treated the same as the public sector.
As part of any bailout, Mario has insisted that the IMF will be brought in. Let me be very clear on this. The IMF is always Senior to pubic holders of debt. This means that the IMF will be Senior to the ECB as to the right of repayment. Do you get this German citizens? This means that Draghi has put you on the back of the bus!
There is a reason that governments and the IMF have always been treated as senior to other creditors. These types of lenders are not in it for the return, they are forced into lending as a result of a crisis. Tax payer money is at risk when cross-border bailout loans are made. Those types of creditors should have protection over commercial lenders who made a mistake. That has been the tradition in all sovereign bailouts over the past 100 years. Mario has broken new, and very dangerous ground with this step.
D - Collateral requirements have been a sticking point for the ECB. Not any longer. With a wave of his hand, Mario has said he will accept any junk collateral that is out there. Busted mortgage loans, crappy corporate assets and un-payable sovereign debt is now going to be eligible for financing at 100% of par at a dirt cheap price.
In the end, the people in Germany will own this crap. The cost will be staggering. I can't imagine how the German politicians, the Bundesbank and the German people can allow this to happen. They are getting fleeced by a guy from Goldman who has allegiance to Italy, not Europe.
E - I wait to see if the promise to sterilize all purchases of debt is delivered on. If this is done in small amounts (under E 200Bn) I think that it could be done in a sterilized manner. But there is little chance that it can be done in the Trillions of Euros that will be required. To live up to the promise of "unlimited", Draghi will have to print money. To think there are no inflationary consequences attached to the Draghi plan is just wishful thinking, or outright lies.
F - I don't think that the objective of eliminating the impediments that have clogged up the "transmission of monetary policy" has been met with Draghi's efforts. Quite the contrary.
For the ECB to implement the new measures for a country like Spain, the first condition is that there must be a crisis in the markets that forces the government to go begging. So now we must wait for a crisis to occur. This is the environment that allows for the smooth transmission of monetary policy? I would think not.
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I try to never to stand in the way of market sentiment. All of the signs point to the conclusion that the market is satisfied will what Draghi has delivered. The most conclusive evidence comes from the EURCHF market. For the first time in many months, the key cross rate is above the floor set by the Swiss National Bank. So Draghi has succeeded.
Me?, I think he has set the EU, and the rest of the world, up for a very big fall. Nothing he did will change the economics in Spain. More austerity for this country will not fix the problems, it will make the problems worse.
What Draghi did is buy some time. The only question is, "How much time?" My guess is that it will take three months before we are back in crisis mode.
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You have to bet your farm on the government to print money to get out of the hole whenever there is a crisis. Its their life at the stake. Kicking the can is the way of surviving. Betting on the collapse of the system is a losing bet. A straw to break the camel's back is one in the life time event, and it doesn't happen everyday. If the smartest people all work on the problem there will be a solution, especially when they have a large printing machine at their disposal. I don't know how and when this problem will be solved, but I believe it will be solved, and the end result is more fiat money around.
No idea why people are collectively choosing to junk reality. These assholes are going to print like their life depended on it, is the basic gist of your post. Wait, now I get it.
"If the smartest people"
There was your error. Since when do smart people work on this shit?
Smart or dumb is your judgement. These people are in power. They will do whatever it takes to stay that way. There is no other way except to turn that printing press to the maximum. I know people don't like my way of saying it, but that will be the result.
Way to summarize the absolute futility in their 'dazzle them with bullshit' plan. I'm sure it will work swimingly.
Great post again, Bruce.
Yawn.
The fascists have all the power: the electronic printing press and the U.S. military ready to blow up the world if their Overlords are to lose a penny to back them up.
For these that expect EURO or US to break / blow tonight or manana you should know it will take some more time to get there. What is going to replace them? Peso? Real? Ruble? The things in economy take longer than expected but when crumble they crumble much faster than expected.
We're not there yet. Dollar used to represent about 72% of all the money in circulation some 10 years ago; today that percentage is at about 63% so it took 10 years for 9 percent decrease. Even with, say 25% of the all the money in the world in dollars, the Overlords would have their fun.
"We're not there yet. Dollar used to represent about 72% of all the money in circulation some 10 years ago; today that percentage is at about 63% so it took 10 years for 9 percent decrease. Even with, say 25% of the all the money in the world in dollars, the Overlords would have their fun."
Said overlords control every major currency, including:
USD
EUR
GBP
CHF
JPY
CAD
AUD
NZD
DKK
SEK
The six entities that control these currencies:
The only real battle is petrol/NG/commodity backing, ergo the constant warring in the ME, Africa, and the Balkans/Soviet orbit.
What is going to replace them?
Silver.
Unfortunately, collateral and wages do matter. The reset will come by default or hyperinflation. Since banks and financial houses now own all western governments, I think you know what path will be chosen. Then war, of course. Hedge accordingly.
This is ZH dude, no hedging allowed. Commit!
There are many signs of collapse, that is for sure. It seems the history of empire-collapse-war is repeating itself...almost exactly as hundreds of times before. Will this time be different? Not substantially, but the internet and rapid technological progress do introduce some wild cards into the equation. Will the common people of the world be able to connect and see through the empire-collapse-war model of the oligarchs? It is possible, IMO, but then I am sort-of an optimist. Maybe the CBs, bureaucrats, central planners will be left alone to destory their "facade of prosperity" while the rest of the world moves onto a new path. I guy can hope, right?
If the ECB can't print money (monetize debt) where are they getting the money to buy all these bonds at artificially low rates?
They'll print it, but promise to sterilize it.
It's probably some sort of ultraviolet light thingie.
They have to kill the germs on their computer keyboards before their lunch break, you know. You can't have central banker drones getting sick when there is keystroke money to be printed. UV light and ozone work wonders for sterilization.
Maybe the mayan calendar was predicting a financial armageddon for Dec.21, 2012?
Seems right to me.
If you believe that I have a lucky rabbit's foot that will protect you for all harm. Except of course, your own ignorance.
The timing is certainly there.
Wow... 12-21-12. Just look at those digits? Turn them around, inside out and back again... just say'in (/s)
what really sucks is that starting in 2013 we cant have any cool 'disaster dates'...cant have 13-13-13. we will have to wait til the year 3000 to 3012. that really sucks...
The timing is certainly there.
3 months is the magic number. That's the point. To make it through the election. Romney/Ryan is a wild card. There is some unpredictability. Obama/Bernanke is a known commodity. They have and will continue to print both through deficit spending and base money creation. The crisis is coming Jan 1st. Fiscal cliff/debt cueing limit. It's all about making it through The election. Après ca, Le deluge.
If you think the U.S. congress and administration will do nothing and let the U.S. drive over the "fiscal cliff" on Jan 1, 2013, then you really haven't been paying attention to how the U.S. political system works. Just as in Euroland, there will be a lot of tough talk leading up to that date but in the end they will extend-and-pretend once again. The Bush era tax cuts will simply be extended as will be the debt limit accompanied by solemn promises to get tough on the deficit in the future.
The Congress is passing a 6 month continuing resolution. Nothing will be done about the so-called "fiscal cliff" before January 2013. In fact, with a CR passed, there is actually no need for the Congress to return after the election. And if you are a lame duck, you won't want to return anyway. I am quite sure that sequestration will happen on schedule and that the tax cuts will expire on schedule. Now the new Congress can adjust the sequestration and tax rates after the fact, in Feb or Mar 2013, but nothing will be done before the fact. They know that they have 2-3 months to undo any temporary harm, and deals are always made at the last minute.
But then again, maybe not...after all, if the Cliff comes, the Congress can then re-fund their favorite (military) buddies.
Actually, dear Bank Guy in Brussels, Mr. Bunga Bunga (and I would vote him again if he once again cancels the real-estate tax, like he did in 2008) will have a tough time getting re-elected as he (and his perhaps old and new allies) barely seems to be at 30% in the polls. Secondly, in this country (Italy) sovereign debt is on par with corporate debt (both at about 128% of GDP) while household debt is estimated at about 45% of GDP but as Mark Grant showed right here on ZH, the sovereign debt is actually well over 200% and the second and third figure are also, in my opinion, underestimated by a country mile. As far as getting out of the Euro....uhm well I couldn't care less if it happens (got Gold!) :)
Best regards.
"Any bond purchases that the ECB makes, will be immediately sterilized. This single step eliminates the possibility of any inflationary consequences."
How is this supposed to be done?
The keyboards will be sterilized with lysol spray or UV generated ozone.
Well, I was trying to be tongue in cheek on this.
Read the later sections where I conclude that this is just mush. A promise that will be broken.
Bruce, is this move in line with your Two tier theory?
Will not unlimited sterilsation be impossible in the strict sense? At least the Buba thinks so!
On the longer term inflationary issue I have posted this : 2770928
Yes. Mario created a two-tier. Bonds with a maturity of 3 yrs or less will be treated differently than those with long term maturities.
If you own 5 year+ Spanish paper, you are not protected. In fact, you are at greater risk. When this gets reflected in the market, the overall pressure will rebuild.
Any thoughts on the adhoc "ownership" of the Target2 system? Would that majority position mean that you can re-define the concept of "reparations" to include public sector costs associated with the war against the "speculator"?
If I were sitting at the table, in a chair that was not comfortable, I would ensure I had control of Target2 plus any global system and use that position to extract reparations to pay the bills. If the PIIGS wanted to create Target3, go ahead. Capital will flee risk and feed the German/US/UK banking system.
Europe is over-banked anyways. In the future, if the PIIGS banking system wants to play in the real world, they need to get "real"...
Did the UK ever sue Iceland? Does that mean it won't happen in the future?
the logic would be to eliminate the 5 year+ bonds from the offering...now that would be a game changer and I don't think its technically possible...unless...
Imagine if the ECB used a back door means to buy up that 5 + year paper...that would be the logical thing to do to protect the two tier from going on a total shear...look for the clues before it unglues.
Here is what Roubini has to say on this :
ROUBINI: The ECB Will Not Allow Spain And Italy To Play Any Games Over Bailouts - Business Insider
'[Official] lenders are not in it for the return, they are forced into lending as a result of a crisis.'
Although they aren't in it for the return, English central banker Walter Bagehot famously advocated lending to illiquid-but-solvent banks at a penalty rate.
Central bankers now routinely break both of Bagehot's prudential rules. They lend to the insolvent, and they lend at preferential rates, thus rewarding bad judgment.
In pre-Fed crises up till 1907, overnight call money would soar to 50% and 100%. And that is exactly as it should be, as lending during a crisis carries higher risk.
By doing high-risk lending at near-zero rates, central bankers reward the imprudent and blow bubbles. Morons!
Thanks!
It's always good to see Walter Bagehot: common sense isn't dead ...
financial desperation knows no bounds like mad love!
I love this quote by Bruce :
The IMF is always Senior to pubic holders of debt.
Now "pubic" is what "pubic" does!
I'm mad about words!
Maybe Bruce should get us to pre-read his posts before they go on BI!
That's MSM!
Having said that "pubic" in this context is so hilarious its priceless. Well done Bruce!
Draghi indeed did kick the can, as Bruce Krasting suggests he was able to 'buy some time'.
Germans are going along because they fear the dark alternative, where trails lead to the chance of implosion for German banks, insurers and pension funds.
Despite the particular well-grounded criticism of the details, as covered by BK, there still seems to be a medium-term power to money-printing in the face of an ongoing whirlwind of credit and shadow banking contraction ... so BK's suggestion of a blow-up 'ahead', may yet take a while.
Overall I am inclined to think Ambrose Evans-Pritchard has it right ... Unless Germany and the Northern nations depart the euro in a bloc, the southern countries will start leaving, in an uglier, more disorderly and more consequential way ...
And my inclination is Italy may be the first, as Berlusconi rides back into office on an anti-euro platform. As Evans-Pritchard points out, of all the GIIPS countries, major-exporter Italy (with low household and non-sovereign debt), has the clearest Latin country case for exiting the euro to its own major and immediate benefit
bank guy - appreciate your insight as to the timing of the "blow up".
However if Italy does leave the EUR "for its major and immediate benefit" that benefit will last about as long as it takes to say "Ciao".
The new ITL lira will be a depreciating currency and Italy's energy and fod costs will skyrocket. There will be chaos in the streets.
There is no way out for any of these EUR countries. Their quasi socialist goernment policies must fall and be swept away. Who / what knows will emerge from the chaos.
1) politicians are just the best BS'ers. When it comes to thinking or problem solving, they are out of their element. (see our two choices)
2) the Pre-election Israel/Iran war should render all this analysis moot.
Germans are NOT worried about their banks. The banks can always lay off the bad paper on BuBa. Germans ARE worried about their export-driven economy if the EUR fractures -- either by the northerners leaving (DM, etc. would strengthen against the EUR) or the southerners departing (Drachma, Lira, Peseta, Escudo weakening vs. EUR). The German manufacturing economy would go into a tailspin for years.
No matter what you may hear from the clown car, THERE IS NO HAPPY ENDING to this mess. The bitter pill (defaults and the end of free money) is tough medicine but it has to be swallowed before recovery can take hold.
You always seem to have thought provoking insights. Great post.