As previously discussed, it is possible their deficits already got high enough and the euro low enough to support very modest growth when market forces intervened to stop further fiscal expansion.

One problem now is proactive cuts can set them back if a combination of private sector credit and exports doesn’t expand at the same time.

And expanding exports remains problematic as that would tend to strengthen the currency to the point where net exports remain relatively low, and there is nothing they can do to keep the euro down should that happen.

Another problem is the market forces that are working to limit their fiscal expansion will continue to hamper their ability to fund themselves, especially with continuing talk of ‘restructuring’ which, functionally, is a form of default.

I’ve read the ECB is now buying about 10 billion euro/week of national govt bonds in the secondary markets and ‘learning and demonstrating’ that it is not inflationary, doesn’t cause a currency collapse, and poses no operational risk to the ECB as some feared it might. As they all become ‘comfortable’ with this look for market forces to ‘force’ them to expand the buying geometrically as happened with their funding of their banking system, where much of the ‘risk’ is now at the ECB as they accept collateral for funding from their member banks that no one else will.

Operationally the ECB can fund the whole shooting match. And if they can address the moral hazard the usual way via the growth and stability pact, this time with the leverage of being able to threaten to cut off ECB funding to punish non compliance.

This ‘solution’ of the ECB buying national govt debt in the secondary markets is conceptually/functionally nearly identical to my proposal of per capita distributions to the national govts by the ECB. The difference is my proposal would not have ‘rewarded bad behavior’ as theirs does, but that’s a relatively minor consideration for them at the moment, and if they continue doing what they are doing, they have ‘saved the euro,’ even though having the ECB fund all the banks and national govts wasn’t their original idea of how it all would end up.

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2 Responses

  1. I think you are being a bit too sanguine about the euro. Just because the ECB has stumbled upon the solution doesn’t mean they stay with it.

    As of 6/21 the ECB had bought 51bb in debt. The last dealer analysis I read had 75% as Greek, the rest Portugal and Ireland, with a smattering of Italy and Spain. They won’t release official numbers.

    Remember that the ECB bond buying program was only supposed to “ensure depth and liquidity in those market segments which are dysfunctional”. The solvency crisis is supposed to be solved by the joint IMF/cross government guaranteed SIV facility. Greek 5yr CDS is now 30bps wider than it was on 5/7, the Friday before these programs were announced. My quick calculations show the ECB is at least 2.6bb or 7% underwater on only its Greek purchases.

    Clearly this can give some political firepower to those who want to argue against ECB bond purchases. They can point to these facts and claim the program isn’t producing its intended effect. They might end up scrapping the one program that can actually save them

  2. even though having the ECB fund all the banks and national govts wasn’t their original idea of how it all would end up.

    Funny how things work out.

    When it’s about saving themselves, the bankers will “print.” And, surprise, “the market” won’t care.

    And they are convinced that “austerity” made the space for this.

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