The ECB bond-buying plan

by on August 7, 2011 at 6:52 pm in Uncategorized | Permalink

“The ECB is once again intervening as the last line of defense,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland in London. “The intervention will put a halt to the bond market crash that some member states faced. However, the ECB is now in for the long haul and will potentially have to buy up to half of the Italian and Spanish traded debt, the biggest risk-pulling effort ever engineered in Europe.”

Here is the articleThis analysis by Paul Krugman probably won’t be beaten, and more here.

Arguably it’s now a question of who stares down whom.  If you do not doubt German resolve, bet on the ECB and lend money to Italy fairly cheaply.  If you fear that Italy suffers from its own version of the great stagnation, and doesn’t have good enough political institutions to make decent reforms (and now the hammer of the private capital markets is partially removed), maybe the ECB will cry uncle at some point and give up.  Knowing that, confidence will not return and the speculators will continue to pounce.  We’ll see soon enough what the markets think.

As I am posting this, Dow futures are off about 250 points, although that bad news could be traced to numerous causes.

Speculative attack games can be hard to predict for the marginal cases (personally I am skeptical), but the general uncertainty resulting from the U.S. debt fight, and the resultant “flight to safety” isn’t helping matters.  It’s another way in which our fiscal nonsense brings some very real costs, and quickly.  Have you seen that France might suffer a downgrade from AAA?  In the abstract, that makes sense.  Why should they be safer than the US?  Again, our stupidity makes the European mess harder to resolve by shifting the focal equilibrium from a good outcome to a bad, scary outcome.

Bill August 7, 2011 at 7:04 pm

Does the US S&P downgrade benefit us as it would be less likely we would be asked to assist others, or does that exacerbate the crisis in Europe, which then spreads to the US.

Looks like a bad hair day for EU banks.

Bill August 7, 2011 at 10:08 pm

Will this also prevent the dollar from soaring, as the Swiss franc, choking off exports?

TallDave August 7, 2011 at 7:15 pm

Excellent piece from Krugman. Don’t miss the update, either.

The PIIGS needed to have their Tea Party several years ago. Now they’ve fallen into the land of “The debts are just too big, the required fiscal adjustment just too large even if interest rates were low, to make full payment plausible.” It’s probably too late to cut enough to avoid that fate.

It will be interesting to see how different countries navigate these demographic shoals. Times like this make me wish we had more of a fiscal Darwinism at work, something along the lines of Patri Friedman’s notion of competitive politics, where the winners would gain from the losers. I guess until then, we’ll just to have hope out body politic can learn from others.

jqhart August 7, 2011 at 11:30 pm

If we want a more Darwinian outcome, Germany could always invade Greece again. There’s nothing like a Panzergruppe to enforce austerity.

Oh, you were just thinking about freedom of exit. How boring.

TallDave August 8, 2011 at 10:09 pm

Freedom of exit probably isn’t enough.

What would work better? I don’t know, that’s why we need to do the experiments!

jkb August 7, 2011 at 7:27 pm

Certain strains of monetary theory would say that buying bonds – a lot of bonds – is exactly what needs to happen in order to inject spendable cash into a faltering European economy. Because of the EU central bank structure “sterilization” mechanisms appear limited – and that should be a good thing! Analysis, please. Functional – not the “what about hyper inflation” sort that fills the Wall Street Journal these days.

Anon August 7, 2011 at 7:37 pm

How will going into more debt to buy consumer trinkets and pay unproductive people help the economy?

kurt August 7, 2011 at 9:23 pm

I don’t think there’s a free lunch. Doesn’t sterilization make it more costly for banks to raise funds, since the ECB takes deposits out of the system? It just seems an awfully expensive way of just doing nothing, just so politicians in Europe get more time to not figure out what to do.

Former Beltway Wonk August 7, 2011 at 11:39 pm

It’s true that hyperinflation isn’t functional. Ask Germans what happened a bit less than a century ago there.

I love how taboo mongering is used to exclude from the mind factors or ideas the taboo monger doesn’t want us to take into consideration. …’not the “what about hyper inflation” sort that fills the Wall Street Journal these days’ indeed. This says far more about the taboo monger than it does about hyperinflation or the Wall Street Journal.

Ignoring the risks of hyperinflation, or for that matter of inflation, isn’t very functional, either.

Stephen F. Thiel August 7, 2011 at 7:51 pm

How do you square the US credit rating downgrade with the powerful price activity of US financial futures?
To me, they feel contradictory.

Tyler Cowen August 7, 2011 at 7:53 pm

Flight to safety, where else to go?

Former Beltway Wonk August 7, 2011 at 11:47 pm

That reminds me, I need to skip my credit card payment this month.so that my credit card company will _lower_ my interest rate.

Or perhaps, as many commentators have been pointing out for the last few weeks, almost every major Treasury investor has far more relevant information than the tiny office of poorly paid Wall Street wannabes and political hacks that work at S&P.

E. Barandiaran August 7, 2011 at 7:58 pm

Tyler, in an earlier post you point out that in Northern Chile they were not ready for the rain. None has been surprised because it never rains. In this post you ignore the fact that the governments of all advanced economies should have been ready for their fiscal crises. We know why they have not been ready and why the fraudulent clowns will continue fighting among themselves even after their crises threaten to ruin their economies.

And then you have a parade of useful idiots arguing for default as the way out as if the advanced economies could restore fiscal discipline just by not paying their debts. Rather than denouncing the ruining of the advanced economies by failing to agree on a fiscal adjustment plan that can reverse the increasing deficits and lead to a surplus, the useful idiots want people believe that there is an easy way out (who will pay attention to them if they don’t have a magic, painless solution?). Some of these idiots are Americans of influence and they like to be seen as providing support for a EU member’s default although they know nothing about Greece, Ireland, Portugal, Spain, Italy, or any other EU country. Tomorrow we will see some “well-known” European idiots returning the favor and arguing for an American default or just for an inflation high enough to wipe out the Treasury debt rapidly.

May I suggest that in your posts you focus on the ideas and proposals of people that are trying to define serious adjustment plans rather than on the useful idiots’ calls for default or high inflation. I’m sure your readers will benefit much greater from understanding those proposals than from celebrating freedom fighters’ calls for a second life, free of debt.

Tomasz Wegrzanowski August 7, 2011 at 8:02 pm

> Why should they be safer than the US?

There’s no GOP in France.

Jay August 7, 2011 at 8:37 pm

France is going to have problems because their immigration policies are even more racist than the US. Without young colored people (there aren’t enough young white people because of the decline in OECD birth rates after 1970) in their country it will be difficult to manage social insurance programs for the aging white man.

Jay August 7, 2011 at 8:31 pm

Krugman is much more readable when he is not under the effects of Bush Derangement Syndrome. Calling the right political group ‘terrorists’ might win you a Pulitzer but it is a poor reflection of an economist with a Nobel.

Andrew Edwards August 8, 2011 at 12:42 am

I think Krugman’s partisan <b<tone causes many conservatives to have an understandably negative gut reaction to him.

I think his substance is extraordinary. He has been substantially right about almost every prediction he’s made for the past 5 years, a record achieved by almost no other economists.

8 August 7, 2011 at 8:35 pm

There’s still time to devalue the U.S. dollar against gold. Set the price above $5,000. Then the Treasury can reprice the gold on its balance sheet from $40 to $5,000, and receive billions from the Federal Reserve due to the change in value of their gold certificates.

It’s not a gold standard, and it ends the current crisis. There will be an inflation spike, but not necessarily a large one. Gold is not used for fuel, food or shelter. It’s just a worthless metal and USG happens to own $#%^ tons of it. Ditto most of the EU countries.

Jay August 7, 2011 at 8:42 pm

Gold is priced based on the laws of supply and demand. The Treasury would have to go out and make a sh*t ton of gold purchases to drive the price of gold up to $5,000 an ounce. They will have to continue to make purchases at that price for it to be maintained. Otherwise, gold prices will plummet like Real Estate when demand fizzled.

Matthew C. August 8, 2011 at 12:15 am

Gold is free market money and being increasingly recognized as vastly superior to the fiat variety. The bubble is in paper promises by insolvent governments.

$1700 an ounce and going up and up and up. . .

8 August 8, 2011 at 2:33 am

I don’t think they would need to purchase a single bar of gold. The physical market is so tight that small purchases have large effects. Jawboning would probably do almost all the work. Even if they had to purchase, they can print the money if they want, but it’s not even necessary. The amount would come to far less than the QE1 or QE2 or TARP. At $5,000 an ounce, it would cost about $150 billion to acquire 1,000 tons.

It won’t solve the spending problem if they keep digging, but it ends the solvency crisis.

Badger August 7, 2011 at 8:46 pm

Most European governments have had better governance than the US have had for more than a decade. Most of them have a better handle of their entitlement and revenue systems, despite their problems.
Most Europeans, on the left and on the right, are relatively in peace with the modern shape of their political economic systems, and reforms happen, but slowly and at the margin. You won’t find there the deep and divisive frustrations found in the US, where both sides appear to be convinced that the country has become something that they both reject while pulling in opposite directions.
And that the Euro imposes fiscal sanity to its members. This is something that sensible economists should be celebrating, not denouncing. Nominal interest rates of 4 to 6% should BTW be seen as *normal*, not as fiscal Armageddon.
Unfortunately, the hands of the Fed are not equally tied by its outdated mandate, so its mistakes just keep accumulating, layer after layer of monetary expansion.

MikeDC August 7, 2011 at 10:25 pm

Yes, the Europeans are in a truly enviable position right now. Their consensus has clearly created a rapidly growing, sustainable, and well-governed society that deals promptly with any looming problems well in advance of the day they become critical issues. Now, it is true that one of the European nations is ill, slightly ill, but the others are just fine, they’re at the controls, handling things, free to pursue a life of religious fulfillment.

Matthew C. August 8, 2011 at 12:09 am

They’re just pining for the fjords. . .

Jean August 8, 2011 at 4:36 pm

You do realize that all of the money owed by the “PIIGS” is owed back to Germany, right? Well, some to Austria and Switzerland too. The EFSF imposes austerity on those countries that have been importing German exports. Germany had too little domestic demand for a long time and they did actually have a housing bubble – on the periphery of the EU. What do they do now? They hated the solidarity tax imposed to ‘fix’ Eastern Germany, which didn’t work btw, and now they’re going to be taxed to bail out Greece, Portugal etc?

Badger August 7, 2011 at 8:53 pm

By the way, better update the notions on population growth before arguing that this isn’t a problem. Without a booming economy, immigration has slowed down significantly, emigration has increased, and birth rates are the lowest ever seen.

Andrew' August 7, 2011 at 9:18 pm

It’s been said many ways, but more tax revenue would just be used to justify more borrowing. Again I ask, is our bond market smarter than Greece’s bond market?

Matthew C. August 8, 2011 at 12:13 am

The stupidity, Tyler, is in believing you can pile up debt forever in a system of fiat tokens and not face the day of reckoning when the whole pile of IOUs collapses of its own weight. To blame this on the Tea Party is like blaming a pothole for setting off the two tons of nitroglycerine bottles bouncing around in the back of the truck.

Former Beltway Wonk August 8, 2011 at 12:25 am

Actually the Democrats and moderate Republicans who stuffed the truck with nitroglycerin are still the ones driving it around. The Tea Party is just yelling from the back seat. Blaming the Tea Party is most like shooting the messenger.

blah August 8, 2011 at 11:56 am

Just for the record, aren’t you the blowhard claiming, ad nauseum, that the market’s failure to signal a downgrade meant that it wouldn’t happen?

txslr August 8, 2011 at 2:04 pm

I don’t think so. I believe the claim was that default wasn’t the natural result of failing to raise the debt ceiling and that the markets appeared to agree. I don’t recall FBW’s opining on an impending downgrade.

That “blowhard” comment was a bit gratuitous, wasn’t it?

Former Beltway Wonk August 8, 2011 at 3:07 pm

Quite right. The hysteria mongers sure do seem to confuse quite distinct concepts very easily. I guess the trouble here is that they both start with a “d”.

S&P rates mortgage securities AAA and they tank. They downgrade Treasuries and Treasuries rise. Presumably by random chance they also get some right. I don’t pretend to predict what S&P’s opinions will be, nor much care.

blah August 8, 2011 at 10:41 pm

Ummm, not really. This original point said nothing about default in particular but more generally about the GOP-led theater which is what triggered all of this:

http://marginalrevolution.com/marginalrevolution/2011/07/from-the-comments-5.html#comments

srsly? July 28, 2011 at 8:26 pm

The irony is that with this escalating theater, the uncertainty is quite possibly going to result in higher borrowing costs not only for the government but for every citizen of the country. Are Tea Partiers factoring those hidden taxes into their equation?

Reply

Former Beltway Wonk July 28, 2011 at 9:42 pm

Or you could actually check out the actual Treasury prices instead of pretending that these floating phobias bear some correspondence to reality. Closed at 2.95% for the 10 year note again today, well within the around-3% it has been trading at for the last several weeks.

Reply

srsly? July 28, 2011 at 11:25 pm

Or you can stop raising the same point ad nauseum and realize that unforeseen events (by the market, anyway) like Lehman Brothers’ and Bear Stearns’ meltdowns do happen.

Markets aren’t always right. Do you have some kind of foolproof crystal ball? Please share if so, Great Kreskin.

Reply

txslr July 28, 2011 at 11:41 pm

Who is arguing that the market is wrong? Not the rating agencies. They agree that the chances of default, particularly in the short-term, are vanishingly small. So who?

txslr August 9, 2011 at 2:34 pm

So I’ve reviewed the thread and it still seems to me that my observation was correct.

UserGoogol August 8, 2011 at 1:05 am

It’s one thing to attack monetary manipulation as harmfully distorting the economy for Austrian-ish reasons, but attacking fiat currency as wrong in itself just seem silly to me. Yes, fiat currency is just numbers on balance sheets, but what’s wrong with that? Lots of things are just numbers. Here we are chatting on a website which is nothing more than numbers stored on a server. Artificial tokens which represent real quantities is what makes the world go round.

And it’s not like fiat currency is the sort of thing where if we just realize it’s all just an illusion its power will go away instantly. (As opposed to this Onion article.) The fact that you can use money to pay people is what gives it money, and the government itself guarantees demand for its “IOUs” by requiring people to use money to pay taxes and treat it as legal tender. It’s not backed by the ability to trade it in for little bits of gold, but it’s an abstract token which is backed up by real social institutions. Those social institutions can manipulate the value of that token in beneficial or harmful ways, (and I’d guess you’d say almost always harmful) but that’s no reason to attack abstract tokens as inherently bad.

Former Beltway Wonk August 8, 2011 at 1:57 am

If the ways they manipulate them even tend to be more harmful than helpful (much less “almost always”), then they are inherently worse than gold or silver, or paper redeemable on demand for same.

MikeDC August 8, 2011 at 8:24 am

History is overflowing with harmful and downright evil manipulation, misunderstanding and misuse of gold as a currency.

Former Beltway Wonk August 8, 2011 at 11:23 am

The scope for manipulating fiat currency is far, far greater. For example, the great inflation of the 16th-17th centuries that many historians have observed was so detrimental? The dollar inflated about _ten times as much_ in the last _forty_ years than gold and silver did in those 200.

MikeDC August 8, 2011 at 12:19 pm

FBW,
However, the last forty years of inflation has accompanied vastly improved living standards while the former had the direct effects of stagnation, plunder and enslavement of societies on a vast scale, and utilizing enormous resources in the cutting edge of technology and capital of the day to… haul hunks of metal across the Atlantic Ocean.

I’d venture to guess that nothing has further retarded economic understanding and caused more needless and counterproductive destruction over the course of human history than the ecstasy of gold.

Former Beltway Wonk August 8, 2011 at 2:57 pm

Wrong again. After the industrial revolution, an unprecedented period of economic progress that occurred under the gold standard, we had rapid real GDP growth and stock market returns during about four good decades for every flat decade (e.g. 1930s). Under the floating currency (since 1970), we’ve had two good decades (80s and 90s, when Volcker and Greenspan were in charge of the Fed and fighting inflation was the top priority) and two bad decades (1970s and 2000s, both with flat or negative real returns on U.S. stock markets). It looks like we’re now in a third bad decade.

Matthew C. August 8, 2011 at 6:44 am

They are inherently bad for two reasons:

1) They can (and will!) be printed to benefit the powerful and well connected at or near the source of the printing press. And everyone now knows that is the case with the dollar / the TBTF banks.

2) Because they can and will be printed in vast numbers in times of economic stress (mainly to bail out imprudent TBTF banks), they are subject to a sudden loss of confidence / massive increase in velocity / drop in purchasing power. This is a social / psychological phenomenon so the printers are powerless to do anything once this occurs.

3) Because “this time it’s different” is what you hear right before a calamitous collapse. Throughout history every single fiat currency has failed. Why is the US dollar better than all the other ones? Because the guys running the printing press are smarter than all the other guys with their printing presses and more responsible with their printing? That one doesn’t pass the laugh test.

Former Beltway Wonk August 8, 2011 at 11:25 am

Well said. I’d add that risk of inflation introduces extreme risk in long-term contracts, which incentives economic actors to wastefully focus on short-term opportunities at the expense of long-term.

mpowell August 8, 2011 at 12:41 pm

Every single gold backed currency has failed as well. If you want a guarantee against loss of value, yeah, you can’t find that in an investment. I find this line of argument as astonishing as it is common. It is hard to understand the claim that our current monetary system is an under performer. In the post war era we have had no depressions and until recently our recessions were brief. And per capita economic growth has been quite strong on a historical basis. In gold-backed eras, depressions typically hit every 20 years or so and were typically associated with significant loss of life. And there are many examples of extremely lengthy depressions, partly caused by a refusal to leave a gold standard.

A fiat currency leaves you vulnerable to the decisions of monetary experts. A metal backed currency leaves you vulnerable to the use of that metal in the economy, population growth and resource extraction. Frankly, it sounds insane and the historical results have been about what you’d expect.

Former Beltway Wonk August 8, 2011 at 3:25 pm

Every single gold backed currency has failed as well.

Interestingly enough, this claim can only be close to being true if we consider conversion of a gold backed currency into a fiat currency to be a failure, rather than an improvement.

As for relative economic growth and stock market returns, “postwar” is not a meaningful epoch. The gold standard ended for the U.S. dollar in 1970 (and indirectly for many other currencies that were pegged to the dollar under Bretton Woods).. Between the industrial revolution, which itself happened under the gold standard, and its end in 1970, was a historically unprecedented era of economic growth, with about four decades of rapid growth for every flat to slightly negative decade. After 1970, 2 good decades, 2 flat to negative decades, and we appear to be in the beginnings of a third flat to negative decade.

it’s amazing what people can believe when they haven’t actually studied their economic history, but merely repeat the cliches and taboos they’ve been taught. Actual historical prices demonstrate that these effects

the use of that metal in the economy, population growth and resource extraction

are quite trivial compared to these:

the decisions of monetary experts.

For example, during the inflation of the 16th and 17th century, much bemoaned by historians, prices in gold and silver rose in 200 years by _a factor of ten less_ than what dollar prices have risen in the mere 40 years since 1970.

Former Beltway Wonk August 8, 2011 at 3:45 pm

BTW, strange how I raised the issue of long-term contracts denominated in a currency, and the risks those contracting parties are exposed to by the possibility of inflation, and mpowell responds with the non-sequitur of “failure” of a currency and hand-waving about macroeconomic history. Want to try actually responding to my point?

Matthew C. August 8, 2011 at 9:15 pm

Except that when a gold currency “fails”, your gold doesn’t go to zero. It doesn’t lose its value.

Zero is exactly what is going to happen to the dollar in the near future, as it has with every other fiat in history.

Kenneth sørensen August 8, 2011 at 1:09 am

Oh, Jacques Cailloux, chief European economist at Royal Bank of Scotland in London — itself bailed out by British taxpayers, and down this week because American investors are unsure about the future of the British support-schemes, –is enthusiastic about an ECB bailout of states, because without it he might loose his job. Tell me some news instead or somethinig I couldn’t have figured out myself

Dan August 10, 2011 at 8:47 am

A question of ignorance: when the ECB buys Spanish and Italian Bonds does it have the same monetary creation effect that asset purchases by the Fed have. If so, I assume that we are looking at a significant move toward monetary expansion in the Euro zone and the consequent inflation and inflationary default by devaluing the currency that European bonds are denominated in?

Gilles August 10, 2011 at 3:14 pm

Great discussion guys, reading it with delight, keep blogging away.
Cheap tablets under 100

The Fresh Prince of Darkness August 13, 2011 at 10:54 pm

Tyler = tool

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