The peripheral economies of the Eurozone continue to deteriorate despite all political and financial efforts so far. The new magic bullet is the Monetary Outright Transactions. This is basically the same as the Securities Market Plan from one year ago. The name has changed to appease the opposition; by including the word “monetary” the ECB can be said to be executing monetary policy rather than financing its failing countries.
The plan is structured like so. The ECB will purchase sovereign debt under three years in maturity and “sterilize” these purchases by withdrawing an equal amount of money from the financial system. The ECB claims that it will not have a preference on the bonds it purchases to make the program more palatable to foreign investors. Of course, there are strings attached for the aided countries. They will be required to formally request aid and agree to a “memorandum of understanding.”
This plan is full of problems. First, the ECB is not permitted to finance countries. Even though these purchases will be executed under the guise of monetary policy, the PIIGS are out of money. Buying their bonds is financing their governments no matter which way you slice it. The reason for this rule is to prevent the European taxpayers from being responsible for other countries’ debts. This is exactly the result of this program.
Second, it is doubtful that the ECB can buy bonds in unlimited quantities without increasing the money supply. Sterilization requires that the ECB withdraw a euro from the financial system for each euro it places there through its bond purchases. If the ECB does this, it risks shrinking the money supply.
With the turmoil in Europe, people are not investing in the Continent. The euros that the ECB exchanges for the bonds will find their way back to safer jurisdictions. Some of the money will flow to Germany, but some of the money is going to be used to buy dollars, francs and yen and leave the system. Italy and Spain have a combined €900bn in debt held by foreigners. Just think of the massive sums that could leave Europe after these foreign investors wisely exit the Eurozone.
Third, using the ECB program as a stick to coerce the peripheral countries into reforming their economies is dangerous. The Eurozone is not the Warsaw Pact; it is a group of democratic countries with duly elected parliaments. It is up to these parliaments to create solutions to these problems. Dictating terms to the Greeks is not working and is creating resentment that will persist for decades, just like the scars from World War II.
Last, this program is not happening in a bubble. The Eurozone is in a recession and heading for a depression. The money to bail out these countries is simply not there. The core cannot afford a Spanish failure now with lackluster growth let alone with the economic shrinkage that is coming.
This program is no game changer. There will some initial exuberance, but ultimately the economic fundamental do not support the turnaround narrative in the future.