In order to garner support for their latest machinations, politicians often use the language of war. In the United States, we have a “War on Drugs,” “War on Terror,” and a “War on Poverty.” Liberals like to talk about the “War on Women,” while conservatives bring up the “War on Christianity” from time to time.
The ECB has a crisis on its hands— the potential dissolution of the eurozone, so it freely uses the language of war to impose crisis fighting tactics on the population. We’ve heard about Draghi firing his “big bazooka” and the ESM’s “firepower;” now add “guerilla tactics” to the ECB’s war lexicon.
A former ECB banker working at Goldman Sachs told Bloomberg all about these guerilla tactics today. The subtext is that one of his colleagues leaked these latest ECB plans to him, which are
With a Spanish aid request “a question of when rather than if,” Pill predicted the ECB will then intervene sporadically to anchor short-term Spanish bond yields near where they are now rather than try to propel them much lower with large-scale purchases. If investors doubt the ECB’s credibility, the central bank may burn them with losses, he said.
The ECB is warning potential short-sellers of a bear trap. If speculators short Spanish bonds, the ECB will attempt to bring yields down by open market purchases. He telegraphs even more of the ECB’s intentions:
If scepticism does arise, it may allow short-term yields to gain anew before re-entering markets to purchase bonds and impose losses on those who bet against it, he said.
This is a warning to short-sellers that since the ECB is in control of everything it may be allowing yields to rise to trick them into the bear trap, so they should not take advantage of price improvements to establish short positions. He states the ECB’s goal thus:
In the end markets will be disciplined and the ECB will be successful if people who take on the ECB make losses and people who purchase in line with the ECB make profits,” he said. “That’s the way to create a type of self-reinforcing low rate anchoring at the short end that the ECB’s trying to achieve.”
I think what the ECB is trying to achieve is a rigged market, first by jawboning and then by its own purchases.
Those who cannot do, threaten. If the ECB was strong enough to implement these plans, it would not threaten markets by announcing its tactics in advance. In war, you shoot; you don’t talk.
The ECB’s plans will ultimately backfire. The central bank is slowly but surely crowding investors out of the periphery sovereign bond markets. Cyprus, Portugal, Ireland and Greece do not have access to long-term financing. Spain and Italy have lost the foreign money and rely on captive domestic investors for their ongoing financing.
By announcing its tactics in advance, the ECB is allowing speculators to front-run its plan. They will continue to purchase periphery debt bidding down the yield to what it deems acceptable levels. The consequence of this action is that risk-averse investors will not enter the market at those low yields so that the only money coming into these markets is from captive domestic institutions, speculators and the ECB.
To contrast, northern tier countries are receiving investments from all market participants. It follows that the ECB’s actions, while maintaining a stable disequilibrium, are actually doing greater long term damage be also fostering a two-speed Eurozone, a north with no financing problems and a periphery that must rely on gimmicks to keep selling debt.
The long-term consequence of the ECB’s actions will be that it winds up being the major holder of periphery sovereign debt as it crowds more and more investors out of sovereign markets. That is, if Germany allows this. If the paymaster says no, the whole thing will run right of the rails.
The Eurozone’s problems can be bandaged in the short-term but will not heal unless monetary policy is coupled with policy action from national governments:
Does the political will exist to enact these difficult reforms?