Oh Mario, you big tease. From the FT on Thursday:
Mario Draghi, European Central Bank president, has called for a “fiscal compact” between governments to restore investor confidence in the eurozone – and hinted such a step could pave the way for a more aggressive ECB response to the region’s debt crisis.
In other words, your move Angela et al.
Now, it’s widely held that the sequencing of any action is important — though not as important as the presence of action, any action — and with the December 9 meeting of European leaders approaching, hopes are once again high-ish for some form of plan.
A charitable interpretation of Draghi’s speech is that the ECB is waiting for a firm commitment to further fiscal union before targeting government bond yields and/or introducing QE. A less charitable interpretation is that it’s yet more prevaricating and neither the ECB nor the main eurozone countries want to make the first move. Frankly, it’s a perverse game of chicken whichever way you look at it.
Our earlier post quoted RBS strategists on why they think QE by the ECB before fiscal union would be an error. For an alternative view, though, we recommend a note by Credit Suisse from Monday. It’s ominously titled “game over” and argues that “conditions will increasingly justify the ECB embarking on QE early next year.” CS doesn’t think there’s enough time for fiscal union — QE must come first.
The CS strategists write that Germany (“the paymaster”) has to urgently decide between two “evils” — “activating the ECB printing press more decisively or Eurobonds”. In our view, it’s not an either/or situation, but CS argues that Treaty changes would take years, which the eurozone, needless to say, no longer has.
What about that pesky price stability target?
First, CS points out that it wouldn’t be the first time rules have been broken during the eurozone crisis. Less flippantly, it argues that QE and price stability are not necessarily antithetical. (Sorry, we should have told German readers to look away then. Apologies.)
From the note (emphasis ours):
The term quantitative easing is not found in the treaty and so far, the sovereign debt crisis has been a sequence of rearguard actions and capitulations.
It would be far easier to announce large scale asset purchases along the lines of QE as long as it is announced as a monetary policy tool. This would not be against the treaty since under the latter, the ECB has a clear price stability objective of below but close to 2%. The backdrop is given to use QE as a monetary policy tool. The euro area is sliding back into recession, which will be accompanied by a mounting risk of deflation exacerbated by the fact that the periphery has embarked on large scale fiscal adjustment and has started to restore competitiveness through relative price declines. The risk that in the medium term, inflation undershoots the price stability objective, is thus not negligible. Even the German orthodoxy, which likes to take its cues from money supply can rest assured that the risk for price stability objective is on the downside rather than on the upside.
In order to use QE as a monetary policy tool, interest rates need to have reached the zero bound. The euro area composite PMI signals that the ECB’s key policy rate should fall well below 1% and the zero bound should be reached at a repo rate level of 0.75% or perhaps even 0.5%. Our forecast currently has the ECB cutting rates to 0.75% by early next year.
But doesn’t this equate to deficit financing? No, argues CS. Not if QE buys bonds from all 17 eurozone countries. Then, providing we’re at or near the zero-bound, it’s price stability. Hmm. It looks like shifting debt once again from one balance sheet to another, only this time to an official sector that is hardly keen to recognise losses. But desperate times and all that.
Let’s ignore the rights and wrongs for now though, and look at the distribution of possible QE purchases by the ECB. Here’s CS’s estimate, assuming €1,000bn, and that purchases are based on the capital contributions of the member countries:
Here’s where it gets interesting. Under such a scenario, countries with relatively low debt-to-GDP ratios are likely to benefit more. Look at exhibit 10 below to see how much of Spain’s outstanding debt would be purchased. Exhibit 12 is also interesting — the AAA eurozone countries would see negative net issuance in 2012 under CS’s scenario.
And here’s where it gets really interesting. CS notes that this doesn’t answer how any future losses would be underwritten.
Bonds bought by the Fed or BoE are issued by their own treasuries and thus have no credit risk attached. For the euro area, a union of 17 national sovereign states, this is different. But the credit risk for the ECB could be circumvented if the euro area as a whole would underwrite these bonds. Euro area member states might acquiesce once there is no other option.
Which in effect sounds to us a bit like… backdoor eurobonds!
CS argues that moving without more fiscal commitments is a risk worth taking. We’re not as convinced it will act as a spur to reform but CS may be right in arguing that the eurozone could be forced to act this way regardless.
On Thursday, hopes of either eurobonds or QE were still being dashed by European leaders.
The full note is in the usual place.
Draghi’s fiscal compact – FT Alphaville
Germany’s Third Great Mistake? – Daniel Susskind
“The moral superiority of the Germans” – Tyler Cowen
Righteous to the bitter end – Free Exchange (response to Cowen)