The Danger of the ECB Mimicking the Fed
Published in Le Figaro
(France) on 16 November 2011
by Pierre-Yves Dugua (link to original)
(France) on 16 November 2011
by Pierre-Yves Dugua (link to original)
Translated from
by Cynthia Perez.
Edited by Jennifer Pietropaoli.
I'm constantly reading worrisome propositions from investors, ministers and European bank policymakers concerning the role the ECB should play in stopping the surge in Italian bond yields.
They all refer to the role of the Fed or the Bank of England as a last resort buyer of government bonds. We hear: "The ECB just needs to follow in the Fed’s footsteps and buy Italian government bonds in large quantities. The Fed did that for U.S. treasuries and by doing so showed its unconditional support for the treasury market.”
All this is completely untrue and frankly, pretty crazy.
What is the Italian (or Spanish) crisis about? It's about defending access to the market, that is, artificially maintaining the rates at which a deeply indebted country can borrow below the threshold (which is about 7 percent) on the capital market. The ECB would be expected to buy pre-announced Italian government bonds in massive and unlimited amounts in order to lower the yield to a level that would render Italian debt capable of being refinanced.
But the Fed never had to defend access to the market by way of the Treasury.
Saving Uncle Sam from not having enough buyers for his bonds has never been an objective of the Fed’s quantitative easing policy. Perhaps this day will come, but for the moment, that hasn't occurred.
The quantitative easing applied in 2009 and then in 2010-2011, was limited in duration and quantity. Its objective was to control the interest rate curve. It was a question of lowering long-term bond yields, which although already very low, the Fed wanted to lower even further.
Why? Because the housing crisis was at the origin of the financial crisis in the United States and low mortgage prices are considered essential for supporting the market.
But to say that the Fed used quantitative easing to save the American bond market is completely inaccurate.
On the other hand, the crisis lowered American bond yields to unprecedented levels. America's problem since 2008 is not at all the same Italy, Spain, or Greece’s current problem. There is no loss of confidence in American paper currency. Even S&P’s downgrade of American debt hasn't prevented U.S. Treasury bonds yields from falling.
The Fed, which was ridiculed by Europe in 2010 for practicing quantitative easing, is now being referred to as a role-model to push the ECB to churn out paper money. It’s amazing.
Conclusion
1) One can question the legitimacy of the Fed's quantitative easing. One can also point out the bad message it’s giving concerning the risk of weakening the dollar and therefore causing inflation. One can be also alarmed at the disappearing line between monetary and fiscal policy. That is all legitimate and important.
2) It cannot be said, however, that the Fed had to come to the rescue of a disappearing demand for American dollars. That has not yet happened.
3) It has previously proven very dangerous for a central bank to defend exchange rates against the market (as was done in the 70s and 80s). The market is much more powerful than a central bank. Today some would like the ECB to defend Italian bond prices, but that would be repeating the same mistake and there would be major interventions for several quarters.
I am not an expert on the European economy, but this action seems unrealistic unless we also agree to inflate the ECB's balance sheet because after Italy, the same would have to be done for Spain, France and so on.
The market will always be more powerful than central banks. Minor interventions that prevent a loss of control are fine, but the return of credibility is the only way to solve the confidence crisis. In order for that to happen, there needs to be growth (which isn’t brought up enough) and discipline, that is, a stable political consensus with a healthy budget policy and job market reforms. The idea that upcoming elections will challenge all of this scares investors.
Let's not use currency to make serious economic structural policy.
They all refer to the role of the Fed or the Bank of England as a last resort buyer of government bonds. We hear: "The ECB just needs to follow in the Fed’s footsteps and buy Italian government bonds in large quantities. The Fed did that for U.S. treasuries and by doing so showed its unconditional support for the treasury market.”
All this is completely untrue and frankly, pretty crazy.
What is the Italian (or Spanish) crisis about? It's about defending access to the market, that is, artificially maintaining the rates at which a deeply indebted country can borrow below the threshold (which is about 7 percent) on the capital market. The ECB would be expected to buy pre-announced Italian government bonds in massive and unlimited amounts in order to lower the yield to a level that would render Italian debt capable of being refinanced.
But the Fed never had to defend access to the market by way of the Treasury.
Saving Uncle Sam from not having enough buyers for his bonds has never been an objective of the Fed’s quantitative easing policy. Perhaps this day will come, but for the moment, that hasn't occurred.
The quantitative easing applied in 2009 and then in 2010-2011, was limited in duration and quantity. Its objective was to control the interest rate curve. It was a question of lowering long-term bond yields, which although already very low, the Fed wanted to lower even further.
Why? Because the housing crisis was at the origin of the financial crisis in the United States and low mortgage prices are considered essential for supporting the market.
But to say that the Fed used quantitative easing to save the American bond market is completely inaccurate.
On the other hand, the crisis lowered American bond yields to unprecedented levels. America's problem since 2008 is not at all the same Italy, Spain, or Greece’s current problem. There is no loss of confidence in American paper currency. Even S&P’s downgrade of American debt hasn't prevented U.S. Treasury bonds yields from falling.
The Fed, which was ridiculed by Europe in 2010 for practicing quantitative easing, is now being referred to as a role-model to push the ECB to churn out paper money. It’s amazing.
Conclusion
1) One can question the legitimacy of the Fed's quantitative easing. One can also point out the bad message it’s giving concerning the risk of weakening the dollar and therefore causing inflation. One can be also alarmed at the disappearing line between monetary and fiscal policy. That is all legitimate and important.
2) It cannot be said, however, that the Fed had to come to the rescue of a disappearing demand for American dollars. That has not yet happened.
3) It has previously proven very dangerous for a central bank to defend exchange rates against the market (as was done in the 70s and 80s). The market is much more powerful than a central bank. Today some would like the ECB to defend Italian bond prices, but that would be repeating the same mistake and there would be major interventions for several quarters.
I am not an expert on the European economy, but this action seems unrealistic unless we also agree to inflate the ECB's balance sheet because after Italy, the same would have to be done for Spain, France and so on.
The market will always be more powerful than central banks. Minor interventions that prevent a loss of control are fine, but the return of credibility is the only way to solve the confidence crisis. In order for that to happen, there needs to be growth (which isn’t brought up enough) and discipline, that is, a stable political consensus with a healthy budget policy and job market reforms. The idea that upcoming elections will challenge all of this scares investors.
Let's not use currency to make serious economic structural policy.