“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”— Mario Draghi July 26th 2012
No quote better defines Mario Draghi’s seven-plus years as the President of the European Central Bank than that quote. Draghi has thrown literally everything at the deflationary spiral the Euro-zone is in to no avail.
What has been enough has been nothing more than a holding pattern.
And after more than six years of the market believing Draghi’s words, after all of the alphabet soup programs — ESM, LTRO, TLTRO, OMB, ZOMG, BBQSAUCE — Draghi finally made chumps out of traders yesterday.
Draghi reversed himself after December’s overly hawkish statement in grand fashion but none dare call it capitulation. For years he has patched together a flawed euro papering over cracks with enough liquidity spackle to hide the deepest cracks.
The Ponzi scheme needs to be maintained just a little while longer.
He’s not alone. In fact, all the major central banks have been working in concert since the day they broke the gold bull market back in September 2011, when the Swiss National Bank pegged the Franc to the euro which began the era of coordinated central bank policy.
And since 2013’s Taper Tantrum when then FOMC-Chair Ben Bernanke
timidly announced a future without QE the markets have consistently tore at their resolve to normalize monetary policy.
Because when you paper over reality you don’t fix the underlying problems. The losses are still there, hidden in plain sight, held at mark-to-model prices, on central bank balance sheets.
Ben retired and Janet took over. She held the fort for nearly her entire term, refusing to raise rates while Draghi sent rates negative alongside Japan’s Kuroda.
What all of these high priests of liquidity refused to admit to themselves (or anyone else) was that QE is deflationary. Recapitalizing the banking system through wealth transfers known as IOER — Interest on Excess Reserves — wasn’t going to create a sustainable boom.
But at least when the Fed did this, it put the banks back on a path to some lending. It was wrong. It was terrible. But as bad as it was it was better than Draghi who just propped up the euro by buying sovereign debt. Debt that left the banks full of liabilities he can’t allow for a second to be repriced. From the Mises Institute:
In contrast, the ECB has sent no signals of higher key interest rates or a reduction in the huge holdings of government bonds. As a result, for instance, the interest margin of German banks has fallen from around 3.0% in March 2009 to 1.8% today. The transformation margin between yields on 10-year German government bonds and overnight money was reduced during the same time span from 2.8% to around 0.7%. Net interest earnings of German banks shrank from 66 billion euros in 2008 to 28 billion euros in 2018. As the ECB’s key interest rates remain low, net interest income of euro area banks is expected to shrink further.
Low interest rates are a reflection of real yields on potential investment not a driver of how to create them. Investors would rather take miniscule returns or even pay a premium to avoid losing even more in a terrible investment environment.
But, never suggest that in polite company. Central banks have the power of life and death.
Laggards? Slaves to the animal spirits of actual capital markets? Not possible. Don’t make Larry Summers and Paul Krugman scoff at such silly nonsense.
Central bankers are gods among men.
Not one of these academics look at Japan, with more than a generation of QE and no real growth. If they did they would understand they would have to turn in their punditry I.D. cards.
So Draghi finally admitted yesterday that ‘whatever it takes’ is simply more of what hasn’t worked. And his timing couldn’t be worse. Because as Basel III looms :
The markets have been supporting Italy’s sovereign debt market in a prisoner’s dilemma ever since Draghi stopped buying them in December.
Those most exposed to Italy’s insolvent banks are now buying to keep prices from collapsing without ECB support.
How much longer do you think that can go on if the euro continues to push lower, building losses even faster?
Draghi just let the market know he doesn’t have any more weapons.
With his term ending in October, Draghi was hoping he could pass the worst off onto his replacement, like Bernanke and Yellen did. But he couldn’t.
Powell had to admit defeat in January and Draghi had to follow suit.
The result will be further flattening of yield curves all across Europe and the U.S. to raise collateral and have liquidity in the event of a crisis.
The German yield curve is pegged at -0.55% out to 3 years, the 10 year Bund is just barely positive yielding, 0.07%. Draghi’s inability to reverse his great monetary experiment has destroyed not only the European banking system but its sovereign bond market as well, as the massive TARGET2 balances will attest.
After a brief flirtation with concavity, convexity has returned to the U.S. yield curve with a vengeance.
Between Basel III and Brexit on the horizon it’s no wonder the market reacted as violently to Draghi’s policy statement as it did. The euro is now headed back to to the $1.03-$1.05 area and gold has been freed from the shackles of the strong dollar/weak gold trade, ending the week capped at $1300, but breaking out again versus the euro.
Draghi has told the markets what the score is. He’s not Super Mario. He’s just another in a long line of clueless shysters who have reached the end of their scam.
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