Friday, November 11, 2011
Euro crisis is over.
The Euro crisis is over and from what I can see that view is being embraced more broadly.
Yields on Italian gov’t bonds are down sharply again today. The markets and more importantly—the ECB—are coming to realize that the ECB is the rate setter in the Eurozone, just as the Fed is the rate setter in US dollar bond markets and the BOJ is the rate setter in yen. And the mechanism by which the central bank, in this case the ECB, sets rates is by buying or selling the securities of the government in the secondary market. NOT DOING SO would be an abrogation of their role. Just as the Fed can set rates anywhere along the term structure or, even on mortgages, the ECB can set rates on Italian, Greek, Irish, Spanish, German, French or any other debt in the Eurozone. That is its role even if it is reluctant to do it. It is finally coming to terms with that and doing it as needed.
So this removes the solvency issue entirely at this point. As the markets come to realize this, and I believe it will be rather quickly now, there can be a huge relief rally.
Where we go from here depends on policy measures related to ongoing austerity. Austerity deflates economies and that means weaker growth, higher unemployment, not just in the Eurozone, but here as well. That will take time to play out because it is a political process, however, I see nothing in terms of policy that would suggest austerity will not be the norm going forward.
One final note, this is NOT MONEY PRINTING and NOT INFLATIONARY as some analysts are saying. That’s because the buying of bonds by the ECB is merely the removal of one asset from the public—the bond—and replacing it with a cash balance at the ECB. The only thing that has changed is the interest rate and the duration. The public is stripped of a bond interest coupon that pays a pretty high rate and gets a cash balance at the ECB that pays 1.25%. It is therefore stripped of income. This is not inflationary. The duration of the public’s assets has shifted from longer term to zero term (cash). That’s all that happened.
To the extent that markets perceive this as money printing or inflationary they will buy gold or commodities or sell bonds or whatever, but those moves are not likely to hold up.