Recently, the European Central Bank (ECB) launched a significant monetary policy initiative. Their plan involves purchasing €60 billion ($66 billion) worth of European government bonds each month, a strategy that is supposedly aimed at revitalizing the economy.
Yet, many find the European Union perplexing for various reasons. According to J.P. Morgan, the discrepancies between member nations are more significant than the reconfiguration of former Ottoman Empire territories, various countries located five degrees north of the Equator, or all nations starting with the letter “M.” The ECB’s attempts to devalue currency only serve to highlight these absurdities. This brings forth several pertinent questions…
Where does the ECB acquire the funds for purchasing government bonds? Is it sourced similarly to the Federal Reserve? Does the ECB simply create a ledger entry and generate money out of thin air?
Which types of bonds will the ECB acquire? Will they invest in German bunds, French OATs, Italian BTPs, or Greek and Spanish bonds?
How is the allocation of these “funny money” funds determined for each country? What criteria does the ECB use to distribute this capital? Is the preference given to the nations that need it most—or those least deserving?
Negative Yields
These are critical answers that ECB President Mario Draghi must address. In an ideal scenario without ECB intervention, these questions wouldn’t even arise. This leads to another inquiry…
Isn’t the ECB’s bond-buying initiative akin to the Federal Reserve’s quantitative easing programs? While the similarities are clear, the situation in Europe is arguably even more perplexing.
It would be as if the Federal Reserve created money out of thin air to purchase bonds from individual states like Kansas, Montana, or California. The chaos is evident.
Moreover, short- to mid-term bond yields throughout Europe have plummeted into negative territory. This indicates that borrowers are lending to European governments while incurring guaranteed losses. Essentially, lenders are paying for the opportunity to extend credit to these governments.
“Across the euro zone, yields on many short- to mid-dated bonds have turned negative in recent months,” reported CNBC. “Germany’s two-year and three-year bund yields, for example, are trading around the negative 0.2 percent threshold, with the curve not turning positive until the seven-year bund. France’s two-year bond is trading around negative 0.15 percent.”
Clearly, the ECB’s asset purchases will continue to distort credit markets.
The Beginning of the End for the European Union
Just last Thursday, bond yields across Europe decreased. Notably, the economically fragile countries like Italy, Spain, and Portugal reached record low yields. This trend occurs because lower yields indicate rising bond prices—a phenomenon spurred by speculators anticipating ECB actions.
Draghi appears oblivious to the fact that he has transformed European credit markets into a speculative casino. He maintains that the economy is on the mend, believing these measures will finally usher in prosperity for the region.
“While reiterating that the ‘risks surrounding the economic outlook for the euro area remain on the downside,’ Draghi stated that such risks ‘have diminished following recent monetary policy decisions.’
He described the broad asset purchases as the “final set of measures,” asserting that “to increase investment, boost job creation and raise productivity, decisive actions are required to enhance both product and labor market reforms across various nations.”
However, what Draghi considers to be the ‘final set of measures’ may not last long. History has shown us that it is usually simpler to commence quantitative easing than to cease it. Thus, what he deems as final may instead mark the onset of a prolonged asset purchasing program that could ultimately lead to disaster.
Consequently, this moment does not represent an end. Nor is it truly a fresh beginning. Instead, it signifies the beginning of the end for the European Union.
Sincerely,
MN Gordon
for Economic Prism
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