Germany Extracts Stealth Victory Over the ECB | Euro Pacific Capital

Germany Extracts Stealth Victory Over the ECB | Euro Pacific Capital

By: 

John Browne

Tuesday, September 11, 2012

Last week the European Central Bank (ECB) announced what many around the world had hoped it would: A plan that would allow the Bank to “do all it takes” to support the euro. Not surprisingly, stock markets in the EU and U.S. rose strongly based on the feeling that the ECB has now joined the Fed in a massive drive to reflate their respective economies by means of money creation. Many mainline observers and commentators heralded the new ECB position as a fundamental defeat for the Bundesbank, Germany’s central bank and a strong believer in sound money. Reality, however, appears to be a little different.
The deal actually contains many concessions to the German point of view. Perhaps the most important of these was the dropping of the ECB’s previous aim to ‘cap’ the bond yields of Eurozone members. Instead, the previously openended ‘buyer of last resort’ commitment, to keep bond yields low of troubled Eurozone member nations, was replaced by greater selectivity and far stricter conditions—German style. There were other major concessions as well.

• First, any Eurozone member nation that seeks ECB support for its bonds in the secondary market will have to make a formal application. Naturally, such a public application will likely come with political costs, embarrassment and even stigma. Given that asset prices, for stocks and bonds for instance, are so influenced by perception, these pressures will dissuade many member states from going down this road.
   
• Second, any applicant country will have to agree to Germanic-style deficit reduction and economic restructuring programs,which likely come with huge political costs and short term economic pain.
   
• Third, ECB secondary market support will be granted only if the somewhat underfunded European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM) commit their funds in parallel. The Bundesbank has long held that the ECB should not be permitted to abuse its power to create synthetic money without spreading the cost to the rest of Europe and internationally, via the IMF.
   
• Fourth, the ECB’s support is limited to bonds with a maximum of three-year maturities. Eurozone members in trouble will never overcome their excessive debt problems by solely borrowing short-term.
   
• Finally, all ECB bond purchases will be executed exclusively in the secondary market, thereby achieving the German aim to preserve the ECB that forbids direct financing of any Eurozone member by other members.