Hussman: Why the ECB Won’t (and Shouldn’t) Just Print
Over the past week, we’ve heard all sorts of propositions that the European Central Bank (ECB) "must" begin printing money to bail out Italy and other countries, because "there is no other option." There are three basic difficulties with this idea. The first is that ECB buying might help to address immediate liquidity issues of distressed European countries, but it would not address long-term solvency issues, and would in fact make them worse. The second is that the ECB, under existing European treaties, has no such authority, and the prohibitions against it are very explicit. Changing that would be far more difficult than many market participants seem to believe, because it would require an explicit and unanimous change in the EU Treaties that AAA rated countries such as Germany and Finland vehemently oppose. The third difficulty is that even if the ECB was to buy the debt of distressed European countries with printed money, the inflationary effects would likely be far more swift than anything we’ve seen in the United States. This would not "save" the euro, but would simply destroy it by other means.
Investors are not likely to be treated with a "surprise" announcement that the ECB is going to expand its purchases of distressed European debt. Any significant ECB intervention would likely follow a formal revision of EU treaties that trades greater ECB flexibility in return for more centralized fiscal control.
Let’s cover these points individually.
-John Hussman
His is an interesting letter because he highlights the political problem well. The first draft of this post was more positive about his comments for that reason. But I don’t agree with the economics or the legal issues he presents one bit. First, you need a transmission mechanism for inflation and we can all see credit growth in Euroland is stalled both because of demand and supply of credit. QE in the US was not inflationary because there is no transmission mechanism except via the currency and (temporary) shifts in private portfolio preferences; remember the surge in oil and food prices? The euro zone will find itself no different than Japan in being able to manufacture inflation in that environment. It has zero to do with the status of the US dollar. Short of huge currency depreciation, high levels of inflation are not the issue. Moreover, the ECB is already buying up a disprortionate amount of periphery debt in the secondary market. So the claim that the treaties are clear that they cannot is rubbish. You can read the relevant articles of the Lisbon Treaty for the sovereign debt crisis yourself. The ECB doesn’t even have to buy the debt if it sets a rate instead of a quantity.
This is all neither here nor there because it is the political problem which is large, not the economic or legal one. As I said in defense of the ECB last week, “central bankers always prefer to force elected officials to make the tough political choices that are the essence of fiscal policy.” I recommend you read that piece. The ECB wants this whole problem to be resolved by elected officials. Now clearly, what has happened in Greece and Italy with unelected technocrats being installed has created quite a stir. Nevertheless, I think it’s still the case that getting governments to clear this situation through their legislatures is a more legitimate way of dealing with a crisis.
But as I said at the end of the piece (sometimes) defending the ECB:
My concern is that the ECB will play chicken for too long. The buyers of French or Dutch sovereign bonds are pension funds and banks with no risk appetite. They bought these as safe investments with no credit risk. Any bond manager with fiduciary responsibility who benchmarks herself against her peers will be forced to sell these sovereign credits in a down market or risk being fired. This is the essence of liquidity-induced panics. It would behove the ECB to understand this. The longer the ECB waits to act as a lender of last resort, the worse it will get. And it may get ‘worse’ enough to tip us into bank runs and Depression with a capital ‘D’.
Let’s remember why we’re here. European technocrats/policy makers were so deathly afraid of default that they haven’t let Greece or Irish banks default and crystallise loses for the French, British and German banks that hold the debt. Instead they have pretending these entities were solvent and extended the crisis in a way that allowed the whole thing to spiral out of control and infect the rest of the euro zone before they were willing to recognise the three options for the euro zone that were obvious a full year ago: monetisation, default, or break-up.
As I wrote last November already:
We are now seeing euro zone divergence as investors are becoming increasingly aware of the different risk profiles within the euro zone core. But even France and Austria have worsened here. Finland, Austria, France, Germany, and the Netherlands are probably the core of the less indebted nations (see More Charts on Debt in Europe, Germany and the Periphery). Could we see a union of these nations along with Luxembourg, Cyprus, Slovenia and Slovakia (and maybe Estonia) but leaving out two of the founding members of the EU? I doubt it seriously. So, either the euro zone dissolves entirely or it remains intact and creates more mechanisms that bind it together. I still think it will be the latter.
My view is that some combination of monetisation and default is the most likely scenario for Europe.
And since September my view is no longer that breakup is unlikely; the dithering has cost us much. So, let’s be clear: policy makers have caused this problem by dithering. We wouldn’t be here if they had cut the cord early on. Early this month I wrote that I predict that when Europe moves to change its constitution to include greater fiscal integration, it will also include explicit mechanisms for countries to leave the euro area. So I think that’s where this is headed with the ECB also stepping in. Will the ECB step in in anticipation of fiscal union as I have been saying? Maybe, but the outlook is certainly pretty murky and not something to bet on. Rather this is a situation in which to hedge against downside risk; The guys at MF Global would tell you that.
What Hussman is saying is that the ECB won’t move before the national governments do. What I am saying is that this will be too late. The debt deflation will have already set in.
Source: Why the ECB Won’t (and Shouldn’t) Just Print – John Hussman
I read the Hussman piece yesterday and was curious what your thoughts would be on it, since it was a different view than yours regarding whether or not the ECB would eventually monetise. I greatly respect Hussman’s views but I have to side with your thesis over his. His argument, in my opinion, ignores the near certainty that if the ECB does NOT monetise the debt, then there will be catastrophic consequences for the eurozone and therefore for the world economy. Politicians and central banks certainly dither when there’s not a gun to their head, but as we saw across the world in 2008, when they’re faced with Armaggedon, they will pull out whatever stops are necessary (legal or not) to attempt to fix the problem.
If you take Hussman’s argument to its logical conclusion, the ECB would more or less stand by and watch the entire eurozone collapse in a relatively disorderly fashion–leading to the ECB’s own demise as well, of course–and I just don’t see that happening just because the ECB’s mandate doesn’t explicitly support a certain action. The fact that they are already buying Spanish and Italian bonds under the silly guise of “aiding the transmission mechanism” shows that they are willing and able to act when there’s an urgent situation. Now however, as you said…will that aid come too late?
Indeed… this is a really contraversial issue. I’m still unclear of where I sit on the subject.
Just on your comment that “…His argument, in my opinion, ignores the near certainty that if the ECB does NOT monetise the debt, then there will be catastrophic consequences for the eurozone and therefore for the world economy”, I’m not sure whether he’s ignoring this. I think you can take the view that if the Euro project is so fundamentally flawed that a breakup is inevitable, then so be it.
So many of us agree that some form of Euro split in the inevitable end. The reason why we’re having this arguement over ECB buying is because political solutions are not being put forward. The question then is whether the ECB should step in and buy politicians more time to agree on solutions. You could take the view (as Hussman obviously does) that “no, they should not” – find the political solutions or face the consequence – don’t hold the ECB responsible for the Euro’s possible demise – its not their fault.
I read the Hussman piece yesterday and was curious what your thoughts would be on it, since it was a different view than yours regarding whether or not the ECB would eventually monetise. I greatly respect Hussman’s views but I have to side with your thesis over his. His argument, in my opinion, ignores the near certainty that if the ECB does NOT monetise the debt, then there will be catastrophic consequences for the eurozone and therefore for the world economy. Politicians and central banks certainly dither when there’s not a gun to their head, but as we saw across the world in 2008, when they’re faced with Armaggedon, they will pull out whatever stops are necessary (legal or not) to attempt to fix the problem.
If you take Hussman’s argument to its logical conclusion, the ECB would more or less stand by and watch the entire eurozone collapse in a relatively disorderly fashion–leading to the ECB’s own demise as well, of course–and I just don’t see that happening just because the ECB’s mandate doesn’t explicitly support a certain action. The fact that they are already buying Spanish and Italian bonds under the silly guise of “aiding the transmission mechanism” shows that they are willing and able to act when there’s an urgent situation. Now however, as you said…will that aid come too late?
Indeed… this is a really contraversial issue. I’m still unclear of where I sit on the subject.
Just on your comment that “…His argument, in my opinion, ignores the near certainty that if the ECB does NOT monetise the debt, then there will be catastrophic consequences for the eurozone and therefore for the world economy”, I’m not sure whether he’s ignoring this. I think you can take the view that if the Euro project is so fundamentally flawed that a breakup is inevitable, then so be it.
So many of us agree that some form of Euro split in the inevitable end. The reason why we’re having this arguement over ECB buying is because political solutions are not being put forward. The question then is whether the ECB should step in and buy politicians more time to agree on solutions. You could take the view (as Hussman obviously does) that “no, they should not” – find the political solutions or face the consequence – don’t hold the ECB responsible for the Euro’s possible demise – its not their fault.