The trouble with seigniorage | FT Alphaville

The trouble with seigniorage

Gavin Davies asks a good question on his FT blog: Does the ECB really have a silver bullet?

An increasing number of market participants want to believe it does, and some have even convinced themselves that the ECB will pull the trigger on unsterilised bond buying, but Davies remains to be convinced.

And with good reason.

Selected highlights from his latest posting (hyperlink ours):

Willem Buiter at Citigroup and Huw Pill of Goldman Sachs have done the arithmetic independently, and concluded that the discounted present value of all of the future income which the ECB can earn from investments financed by seigniorage is in the region of E2,000-3,000 billion, compared with the total outstanding value of Italian and Spanish bonds of about E2,700 billion.

The implication of this analysis is that the ECB has more than enough “capital” to underwrite the peripheral bond markets, without this being inflationary in the long run. In a single nation state, it would probably prove irresistible to bring forward some of this capital from the future into the present, and then use it to purchase government bonds to resolve the crisis.

The situation of the ECB is different for the now-familiar reason that the institution is the central bank of many nation states, which care very much about the distribution of income and wealth between themselves. The use of the central bank’s non-inflationary capital does not get round this fundamental issue. Since the ECB is owned by all of its members in proportion to their share of eurozone GDP, the future seigniorage of the ECB is similarly owned by all of its members.

In other words if the ECB decides to use what Davies calls its notional capital to buy Italian bonds at subsidised rate, it is in effect triggering a transfer of resources to Italy, away from other members, most notably Germany. (Presumably, the only way round this would be for the ECB to spread its bond purchases across the Eurozone, buying significant amounts of German and French government bonds).

So if neither the ECB or Germany want to fire the silver bullet is there anyone else the markets can turn to?

What about the Federal Reserve and Ben Bernanke? Could they do anything to help?

U.C. Berkeley economist Brad DeLong reckons there is, but in a very parochial way.

I have been complaining for some time now that Reinhart and Rogoff think that the time is always 1931 and that we are always Austria–that the great fiscal crisis is about to erupt and send us lurching down toward Great Depression II.

Well, right now guess what? The time is 1931, and we are Austria.

The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash before the increase in eurorisk leads American finance to tighten credit again and send us down into the double dip.

The Federal Reserve needs to do so now.

Well, it’s probably a better use of seigniorage (or the proceeds of Operation Twist) than buying more MBS or US Treasuries, given how ineffective that the Fed’s programme has been to date.

Related link:
This Is The Way The Euro Ends – Paul Krugman
What’s the hard limit to ECB hard money? – FT Alphaville