Via Mark J. Grant, author of Out of the Box,
"There must be some way out of here," said the joker to the thief,
"There's too much confusion, I can't get no relief”
-Bob Dylan, All Along the Watchtower
Debunking Some Myths
First let me state , with a certain calmness, that there is a Transfer Union underway in Europe. This is the subject, you may recall, that Germany has tried to avoid at all costs which is why Eurobonds and other similar schemes have not been implemented. Europe, however, has found a clever way of implementing such a program and keeping it under the radar from the German citizens. I will explain:
In Greece, Spain, Portugal and Italy the ECB has implemented a program where the sovereign guarantees some bank’s bonds. The bank then pledges them as collateral at the ECB and gets cash. The bank then turns around and lends the money back to the sovereign nation and provides liquidity and economic sustenance. The Transfer Union is completed as Germany guarantees 22% of the ECB and the European Central Bank is nothing more than a conduit to lend money to the various nations. This contrivance is also not sterilized so that the ECB is, in fact, printing money which is another part of this subterfuge that no one in Europe wants you to know anything about. This strategy is what has kept all of these various countries alive while the political entity, the European Union, tries to decide what to do about the future of the troubled nations. In a very real sense the ECB is the only fully operational part of the European construct at present as the European Union does not have the “political will” to carry out its mandate.
“The tears I have cried over Germany have dried. I have washed my face.”
Given what is happening, it then must be declared that the ECB is the lender of last resort and that they are printing money on a daily basis. Sterilization may take place in some instances and for some programs but it is not universally applied or even discussed. The program also gives the ECB tremendous leverage because any threat to turn off the spigot will force any of these troubled nations to turn to the Troika and ask for aid. The assistance does come with a price tag though and it is costly; the nation is audited, reality arrives, and the country gives up the total control of their finances and their budget to the EU/ECB/IMF. In effect, the nation no longer governs itself. The IMF, of course, is nothing more really than a cover for some kind of legitimacy beyond the politics of Europe and it has become the arm piece of the Continent so that Europe can point to them and say, “it is them; not us.”
It turns out that Jens Weidemann, chief of the Bundesbank, is a huge fan of Greta Garbo. Apparently he got to use her famous line recently at the ECB meeting:
“I want to be alone.”
He got his wish.
The total paid-in capital of the ECB at the end of 2011 was $13.7 billion. Currently the balance sheet of the ECB is $4 trillion. The leverage then is 292 times paid-in capital and the other assets must then be assessed as to their solvency. This is one reason why a default by Greece, or any other nation, would be so devastating to the ECB as it would wipe out their entire capital base in a heartbeat requiring re-capitalization immediately which would be politically challenging these days. Now the ECB is thought to be a riskless proposition because, in the last instance, it can print money but this is not a correct viewpoint. There are a number of circumstances that can destroy a Central Bank, any Central Bank, and the first would be the loss of confidence in the institution or the nation (s) guaranteeing it. The second would be actual losses on their balance sheet and while no Central Bank must adhere to marks-to-market; real losses in their portfolio cannot be brushed under the rug forever. I would submit that the ECB, in particular, in having lowered and lowered their collateral requirements is putting itself in a position where their risk profile has increased dramatically. Then there is the risk of some large bank failure in Europe and while the Irish banks, Dexia and Bankia et al have been absorbed by their respective nations and so have had their balance sheets and ratings impacted; there may come a time when the European banks, already institutions with balance sheets three times larger than the sovereign nations where they are domiciled, cannot absorb without serious repercussions, the failure of some large European bank. Finally, in my mind, comes the greatest present risk and this is a run on the banks. This is a quite real present danger which is exemplified by Spain where almost 20% of the capital in the Spanish banks has fled. If the present trend and trajectory continues then we may see a systemic banking failure in Spain which would wipe out not only the banks in Spain but the ECB as the money lent to the Spanish banks goes into default.
Mervyn King, Governor of the Bank of England, once noted that it may not be rational to start a bank run, but it is rational to participate in one once it had started.
The price tag of cleaning up a systemic banking crisis is significant in its size and breadth. The fiscal costs average 13% of GDP and economic output losses average 20% of GDP for important crises from 1970 to 2007 according to data supplied by the International Monetary Fund. Consequently to stare at the ECB and declare it a “risk free proposition” is naïve at best and quite dangerous at the worst. You may think what you like but you must retain sound principles.
“Those are my principles and if you don’t like them---well, I have others.”