The Draghi stratagem

By Luis Arroyo, in Madrid | Steve Randy Walman has a new article where he assesses the strategy deployed by the European Central Bank (ECB) to finance banks and fund euro governments. The strategy has given rise to scepticism, but Walman considers it to be effective although deeply antidemocratic.

Yet, who cares at this point when various elected governments have fallen and have been substituted by obedient technocrats? The new Spanish president, Mariano Rajoy, has clearly chosen to obey, praying that all turns out all right while he closes his eyes and says ‘Sí’ and ‘Amen’ to everything he is told to do. That is to say, get ready because Merkelian adjustments are about to take place in Spain and they will be nothing like what we have seen thus far.

The strategy consist in the ECB opening credits at three years for banks, with public debt as collateral, so that the entities can recompose their assets… by purchasing public debt. How does that work? Well, the banks that need money will buy debt that they then will be able to use as collateral. Thanks to the purchases, the price of debt will rise and the yields will fall, which will then alleviate government financing. This way, the ECB won’t burden its assets by buying the debt directly, but rather it will be the banks that buy it and cede it temporarily, for 3 years, to the ECB where it will remain ‘parked’ for whatever amount of time is considered necessary until things go back to stable.

In the meantime, the ECB (that is, Merkozy) has become the Only Judge that watches over countries’ debts; the country that does not fiercely implement the recommended (dictated) adjustments could face the unpleasant surprise that its debt is not accepted as such collateral…

EU banks are not exactly inclined, as some have expressed out loud, but what can they do? Their governments will force them, or seduce them, with favours so that they play their role in the game.

Now, the question is: besides being antidemocratic, will it be effective? I don’t know. I think it depends on, in the first place, the amounts in question. ‘Full allotment’ is being mentioned, that is, meeting the total amount demanded by banks. Could there be an escape route that increases sovereign deficits? I don’t think so because it is an ironclad system guarded by Merkozy and its ECB. But what I don’t know is if it will be effective in lifting the private sector. In other words, I think there won’t be enough credits for all in a few years, until the pressure exercised by the upcoming ‘pain’ will induce the public sector to deleverage through cuts and taxes.

It seems that Merkel thinks that the system that she applied in the re-unification, tightening and more tightening, must still be effective. Oh well, it definitely worked for her TWENTY years ago.

I should speak with a banking expert to be able to specify the panorama that this newer form of torture ushers in. Do not forget what Mario Draghi said about the limitations of the ECB:

Mr Draghi said the programme would remain justified as long as the financial market ‘channels’ by which its interest rate decisions are transmitted to the real economy remained “seriously impaired”. However, he stressed the EU ban on central bank funding of governments. Asked if that set limits on the ECB’s bond buying, Mr Draghi instead emphasised the need to ensure governments were “trusted on fiscal discipline and structural reforms”.

He hinted he opposed the ECB setting target limits for eurozone government bond yields or for the spread between the interest rate on German and other eurozone government debt. “Monetary policy cannot do everything,” he warned.

Mr Draghi also appeared to rule out US or UK style ‘quantitative easing’, embarking on large government bond purchases to boost economic growth, even if the eurozone fell into a deep recession. “The important thing is to restore the trust of the people, citizens as well as investors, in our continent. We won’t achieve that by destroying the credibility of the ECB.”

That is to say, it is only a matter of mending the ‘financial channel’, not of increasing the demand. He doesn’t care if there is a deep recession and much more unemployment. He is a ‘liquidationist’.

Luis Arroyo is a former Bank of Spain economist. He writes for www.consensodelmercado.com.