I have been thinking about the ECB’s pledge to monetize unlimited amounts of bonds to support failing European countries. The reason to have no cap on purchases is to communicate to the investment community that the ECB stands behind these sovereigns with the infinite power of the printing press.
Each of the European countries belonging to the EU own a a piece of the ECB and therefore a piece of the liability for the EU’s balance sheet. If the unlimited policy were tested, there would come a point where the rich countries would balk. When this point is reached, additional purchases would become politically untenable.
However, it is my belief that once central bank intervention starts, it cannot stop. The intervention takes on a life of its own. This maxim applies to the Fed’s and the BOE’s debt monetization, which is why we will surely see more QE from both entities, and it will apply in the ECB’s intervention, too.
Spain needs to sell €90bn in debt between now and the end of the year to finance its budget deficit and its maturing debt from prior year’s deficits:
There is no way that it will be able to do so. Its main customers, Spanish banks, need to be bailed out themselves. The Spanish people are broke, too. Inevitably, the ECB will begin purchasing Spanish debt.
If it has to purchase the a significant portion of the €90bn required to keep Spain afloat through the end of the year, these bonds will be on its balance sheet. Now, it cannot stop its program, because the bonds will tank causing a confidence killing hole on its balance sheet. It needs this confidence because next year Spain has to finance at least €195bn, more likely €255bn, from its budget deficit and maturing debt from prior deficits:
Once the ECB begins buying this debt in 2012, it will have no choice but to continue the program until the bitter end regardless of the political consequences. Once intervention starts, it cannot stop.