ECB Will Now Print Money Directly … But Why?
By Staff News & Analysis - July 27, 2012

European equities rose and peripheral bond yields fell on Friday on growing expectations of ECB action to bring down Spanish and Italian borrowing costs, but concerns about possible German opposition to such a move kept risk appetite in check. Euro zone governments and the European Central Bank are preparing to intervene on financial markets, French daily Le Monde reported, citing unnamed sources. The report came a day after ECB President Mario Draghi boosted risk assets across the globe with his pledge do whatever it takes within the bank's mandate to defend the single currency. "Now all of a sudden everybody thinks he (Draghi) is going to start printing. He has backed himself into a corner, if he doesn't come up with anything then he could be in trouble," said Ioan Smith, strategist at Knight Capital. − Reuters

Dominant Social Theme: We will never surrender! We will fight them everywhere! Why? … We don't know.

Free-Market Analysis: The market has rejected the euro and the EU. Now Draghi proposes to reject the market. In a groundbreaking reversal, he has indicated he will print currency to buy eurozone sovereign debt.

Mario Draghi, president of the European Central Bank (ECB), will do "whatever is necessary" to ensure a solvent euro. Draghi made the comments at an investor conference at the Olympics. Professional investors like John Fox, director of research at Fenimore Asset Management, believe it may mark a turning point in the four-year old crisis.

"When the head of the ECB comes out and says he's willing to do anything," Fox is quoted as saying. "That's code for 'We are going to agree to resolve this issue.'"

Of course, there may be another reason why Draghi is doing this now but it is nothing that Fox would ever allude to. We'll get to it toward the end of this article.

In any case, one wonders how much of Draghi's statement is merely an attempt to "talk up" the market and how much is grounded in reality. To be sure, he is obviously trying to sound tougher about using an array of monetary weapons at his disposal.

In an article about Draghi's announcement, the Wall Street Journal writes that Draghi "has had enough." Like a previously abashed partner in a bad business partnership, Draghi is going to the show the market who is "boss." He calls the euro "irreversible," and claims the "euro zone has the power to defeat market speculation."

Draghi can make a case for generating price inflation now because the expense of government borrowing is impeding the ECB's ability to conduct monetary policy and to support private sector transactions. He thus has a mandate to "lower … premiums."

Of course, by that logic anything in the marketplace that affects government debt adversely is fair game for the ECB. Please note: The German people were sold the EU and the euro as something of benefit … not as a "transfer union." Draghi may manage to do what he intends, but he is running close to the "red" line.

The ECB sees that interest rates on government bonds cripple private borrowing. It needs to stimulate demand for bonds by buying paper in crippled PIGS countries. Nonetheless, as the WSJ article points out, the ECB is "prohibited from monetizing debt, or buying bonds directly from issuing governments,"

For a while, Draghi tried stuffing European banks full of euros and then basically demanding that banks purchase domestic debt, which would tend to drive down rates. But even €1 trillion wasn't enough. Now, as the Journal article points out with considerable understatement, "it seems Mr. Draghi is willing to ignore restrictions on debt monetization."

There is apparently simply no limit to what Eurocrats will do to keep the EU afloat. The Journal writes that "in theory the ECB is only limited by how fast it can run its printing presses … essentially the speed of light."

What this coy phrase means is that Draghi quite literally presses a button to provide money to designated banks. There is no money anymore, only electronic digits. Despite Draghi's awesome (and unconstitutional) power, he is still subject to the court of public opinion. If he acts too rashly, the all-important German public will push back hard.

For wholesale ECB action not to be inflationary, countries from Greece to Spain would have to stick to their promises of fiscal prudence and to produce primary government surpluses over the next few years–in other words to paying back their debt once interest payments are excluded. Unfortunately, history shows that once market pressure is relaxed on governments, they tend to backslide on spending. (WSJ)

Is Draghi speculating that the price inflation that will inevitably result from his actions shall not prove repugnant to Germans because it may help boost German wages? That seems to be the idea. What Draghi may have decided to do is inflate initially and then try to control inflation after-the-fact … something that central banks are very bad at, regardless of their stated sentiments to the contrary.

Yet there is no getting around the reality that Draghi and his cohorts are pushing boundaries … again. The EU was sold as a trade union but now the socialist Eurocrats at the top obviously intend a repeat of Charlemagne's empire.

Euro leaders going back several decades or more are on record as stating cynically that emplacing a monetary union before a political one was bound to cause problems. The idea was that once a recession occurred, the monetary pressure would inevitably cause closer political ties.

But the Internet has informed many people about this apparent bait-and-switch that it is perhaps not proving so easy as expected in the 21st century to move from an economic one to a political one.

There is of course another perspective within the context of the EU's never-ending crisis as alluded to above. This constitutes the most cynical point of view of all, and would advance the idea that it doesn't much matter if Draghi's latest strategy doesn't work.

After Thoughts

What it IS doing is establishing a precedent for more ECB over-reaching, constitutional or not. That may be the real reason.

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