The Consequences of Unlimited Bond Buying

Guindos Urges Unlimited ECB Aid as Talks on New Terms Planned – Bloomberg.

The Spanish economic minister has quite the chutzpah in requesting unlimited bond buying from the ECB. Spain could cut spending and balance the budget in order to lower interest rates on its debt, but it rather hold its hand out to its allies.

Let’s take an unlimited bond buying program to its logical conclusion using the facts we have learned from previous ECB interventions.

In September, a worsening budget situation in Spain leads to rising interest rates across the yield curve. Super Mario sees his chance to save the euro and begins buying Spanish debt to support the price. Upon the markets learning this information, Spanish yields plunge bringing interest rates to sustainable levels but not for long.

Remember the Greek bailout? The ECB and other institutions made sure they got paid back in full on their Greek bond positions, which meant that private bondholders had to take a greater loss. This preference comes back to bite the ECB. Now, the market prices in the ECB preference, so yields begin to creep back up despite the ECB purchases. Once the ECB is committed to bond buying, it cannot stop it. Investors begin selling their debt at inflated prices right back to the ECB to avoid getting screwed in a Spanish default.

Now, the ECB has a choice to make. It can either monetize the rest of the Spanish debt, or it can withdraw support allowing the market to collapse and Spain to default. Which disaster do you think it will choose?

2 thoughts on “The Consequences of Unlimited Bond Buying

  1. In the Bloomberg article, it’s mentioned that Spain already has in place the sort of budgetary plans that the ECB would likely demand as conditions for further bond-buying. Spain’s running over 20% unemployment and over 50% youth unemployment, what more self-flagellation do you demand from it? It was French and German banks that bankrolled Spain’s bailout of its financial system, by loaning that money those banks agreed that Spain’s plan was a good one. Now that it’s failed to fix Spain’s economy, all the blame is to fall on Spain, and none of it on the creditors that encouraged the policies that created Spain’s debt in the first place? It’s just not reasonable, and it’s not a path forward for Europe. The EU needs to stop defending the French and German banks and start defending the European people from austerity.

  2. Agree 100% with Studebaker. The European banking system is insolvent, as is that of the U.K. and the U.S. Regulatory authorities long ago lost all credibility by allowing this condition to come to be. Thus, it is time for a Glass-Steagall reorganization and consequent debt write down. In parallel with this requires establishment of national banks employing a Hamiltonian credit system, this representing but another self-regulatory arrangement much like Glass-Steagall. The fundamental fact of the matter is this: there is more positively constructive work to be done than you can shake a stick at, yet the banking system is so hopelessly insolvent it cannot afford to finance it. So, it’s time to reorganize it.

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