No let up on the austerity demands, which are now to be legislated via balanced budget rules.

EU Leaders to Agree on Rescue Fund, Balanced Budget

Jan 29 (Reuters) — European Union leaders will sign off on a permanent rescue fund for the euro zone at a summit on Monday and are expected to agree on a balanced budget rule in national legislation, with unresolved problems in Greece casting a shadow on the discussions.

The summit – the 17th in two years as the EU battles to resolve its sovereign debt problems – is supposed to focus on creating jobs and growth, with leaders looking to shift the narrative away from politically unpopular budget austerity. The summit is expected to announce that up to 20 billion euros of unused funds from the EU’s 2007-2013 budget will be redirected towards job creation, especially among the young, and will commit to freeing up bank lending to small- and medium-sized companies.

But discussions over the permanent rescue fund, a new ‘fiscal treaty’ and Greece will dominate the talks.

Negotiations between the Greek government and private bondholders over the restructuring of 200 billion euros of Greek debt made progress over the weekend, but are not expected to conclude before the summit begins.

Until there is a deal between Greece and its private bondholders, EU leaders cannot move forward with a second, 130 billion euro rescue program for Athens, which they originally agreed to at a summit last October.

Instead, they will sign a treaty creating the European Stability Mechanism (ESM), a 500 billion-euro permanent bailout fund that is due to become operational in July, a year earlier than first planned. And they are likely to agree the terms of a ‘fiscal treaty’ tightening budget rules for those that sign up.

The ESM will replace the European Financial Stability Facility (EFSF), a temporary fund that has been used to bail out Ireland and Portugal and will help in the second Greek package.

Leaders hope the ESM will boost defenses against the debt crisis, but many – including Italian premier Mario Monti, IMF chief Christine Lagarde and U.S. Treasury Secretary Timothy Geithner – say it will only do so if its resources are combined with what remains in the EFSF, creating a super-fund of 750 billion euros ($1 trillion).

The International Monetary Fund says an agreement to increase the size of the euro zone ‘firewall’ will convince others to contribute more resources to the IMF, boosting its crisis-fighting abilities and improving market sentiment.

But Germany is opposed to such a step.

Chancellor Angela Merkel has said she will not discuss the issue of the ESM/EFSF’s ceiling until leaders meet for their next summit in March. In the meantime, financial markets will continue to fret that there may not be sufficient rescue funds available to help the likes of Italy and Spain if they run into renewed debt funding problems.

“There are certainly signals that Germany is willing to consider it and it is rather geared towards March from the German side,” a senior euro zone official said.

The sticking point is German public opinion which is tired of bailing out the euro zone’s financially less prudent. Instead, Merkel wants to see the EU – except Britain, which has rejected any such move – sign up to the fiscal treaty, including a balanced budget rule written into constitutions. Once that is done, the discussion about a bigger rescue fund can take place.

Good report!
Additional notations below:

Karim writes:
U.S. GDP growth in Q4 a bit weaker than expected at 2.8%

Perhaps the FOMC had word of this, explaining the unexpected dovishness?

1.9% of that growth accounted for by inventories. Other contributions: (consumer spending 2%, fixed investment 0.4%, government spending -0.9%, net exports -0.1%).

Rebuilding post earthquake supply lines probably now complete.
Govt spending continues weak, as revenues increase some and the federal deficit falls some.
Imports rise quickly with any increase in consumer spending.

In growth terms: (consumer spending 2%, fixed investment 3.3%, government spending -4.6%, exports 4.7% and imports 4.4%).

So stripping away inventories, growth was below trend. Plus savings rate fell back to 3.7% from 3.9%.

Domestic savings down with spending up indicates increasing consumer debt.
The question is whether this is ‘wanted’ as per increased desires to buy on credit,
or because the decline in govt deficit spending ‘forced’ more consumer debt for ‘essentials’

And, core PCE slowed from 2.1% to 1.1%.

Also explains FOMC dovishness as they see risk as asymmetrical, fearing deflation more than inflation.

In sum, will keep QE3 talk very much alive

And somewhat moot, even as Q1 GDP forecasts are being revised down some, as most don’t think QE matters much for the real economy.

What’s becoming understood is that while there is ‘more the Fed can do’
for all practical purposes there is nothing they can do to further support the real economy.

Euro money and lending data shockingly weak in December.

Might partially explain how some banks apparently got the balance sheet room to buy more national govt debt?

In particular, record single month decline in lending to the non-bank private sector (74bn). Of that, 37bn decline in lending to non-financial corporates and 8bn drop in lending to households.

This should be very supportive of additional ECB rate cuts over the next few months.

It wouldn’t be taking this long if there was a way to get’er done?

Not to mention that once haircuts are finalized the obvious political response from the opposition in Italy, for example, is “if Greece doesn’t have to pay why do we?’

Europe Shares Retreat From Highs as Greece Talks Stall

Jan 24 (Reuters) — European shares retreated from near six-month highs as concerns deepened that Greece might head towards a disorderly default and technical analysts said the recent rally could be coming to a close.

The European leadership’s grasp of market forces is even worse than I had imagined.

Unless they somehow cut back on oil consumption, and no one else buys from Iran,
Iran’s sales and prices received don’t change:

Europe Agrees to Ban Imports of Iran Oil; No Date Set
Published: Wednesday, 4 Jan 2012 | 1:01 PM ET
By: Reuters

 
European governments have agreed in principle to ban imports of Iranian oil, EU diplomats said Wednesday, dealing a potentially heavy blow to Tehran just months before an Iranian election.

This is their idea of pro growth:

In a speech given in Paris on January 3rd, the President of France Nicolas Sarkozy confirmed that the country will soon see an increase to the national rate of value added tax and a reduction to the mandatory social security contributions paid by employers.

http://www.taxationinfonews.com/2012/01/president-confirms-tax-hike-in-france/

This is on top of the increase in the reduced rate of VAT in France (from 5.5% to 7%) that was announced earlier.

An increase in standard VAT rate (19.6%) in France (even though still under consideration), could have quite a significant impact on EU HICP and FR CPIx

Ominous start for the new year:

EU Officials Begin New Year With Calls to Save the Euro
Published: Sunday, 1 Jan 2012 | 5:49 PM ET
By: Reuters

 
Policymakers marked the 10th anniversary on Sunday of the introduction of euro notes and coins by urging governments in the currency bloc to save and consolidate to overcome their debt crisis.

 
While German Finance Minister Wolfgang Schaeuble called the euro “a clear success story” and pledged the currency would remain stable, he also urged vulnerable debtor states to follow a tough savings course in 2012, boost their competitiveness and work to win back market confidence.

 
“This is not a euro crisis, it is a debt crisis in some euro states,” Schaeuble told German newspaper Bild in an interview to be published in Monday’s edition of the paper.

When it comes to CB liquidity operations, as previously discussed, it’s about price- interest rates- and not quantities of funds. In other words, the LTRO is an ECB tool that assists in setting the term structure of euro interest rates. It helps the ECB set the term cost of funds for its banking system, with that cost being passed through to the economy on a risk adjusted basis, with the banking system continuing to price risk.

So what does locking in their funds via LTRO do for most banks? Not much. Helps keep interest rate risk off the table, but they’ve always had other ways of doing that. It takes away some liquidity risk, but not much, as the banks haven’t been euro liquidity constrained. And banks still have the same constraints due to capital and associated risks.

To it’s credit, the ECB has been pretty good on the liquidity front all along. I’d give it an A grade for liquidity vs the Fed where I’d give a D grade for liquidity. Back in 2008 the ECB was quick to provide unlimited euro liquidity to its member banks, while the Fed dragged its feet for months before expanding its programs sufficiently to ensure its member banks dollar liquidity. And the FDIC did the unthinkable, closing WAMU for liquidity rather than for capital and asset reasons.

But while liquidity is a necessary condition for banking and the economy under current institutional arrangements, and while aggregate demand would further retreat if the CB failed to support bank liquidity, liquidity provision per se doesn’t add to aggregate demand.

What’s needed to restore output and employment is an increase in net spending, either public or private. And that choice is more political than economic.

Public sector spending can be increased by simply budgeting and spending. Private sector spending can be supported by cutting taxes to enhance income and/or somehow providing for the expansion of private sector debt.

Unfortunately current euro zone institutional structure is working against both of these channels to increased aggregate demand, as previously discussed.

And even in the US, where both channels are, operationally, wide open, it looks like FICA taxes are going to be allowed to rise at year end and work against aggregate demand, when the ‘right’ answer is to suspend it entirely.

While not my first choice for public policy,
the 20 billion euro ECB bond buying isn’t nothing.
It’s something over $1.3 trillion per year at current exchange rates.

At the macro level it sort of funds the entire euro zone deficit spending.
And deficits are currently reasonable high.

So, even while recognizing that timing is everything,
the solvency issue could be in the process of stabilizing as the various ‘new’
‘E’ funding proposals and IMF come closer to fruition.

Not that the euro economy will boom anytime soon
as austerity measures take their toll,
but that ‘leg 2′ of the relief rally could be in progress.

As expected, it’s all about fiscal responsibility which they believe is the cure for their funding issues.

Their actual economic problem is a shortage of aggregate demand and their response continues to be measures to reduce
aggregate demand further.

All efforts are focused on funding being conditional on further austerity.

As previously suggested, it’s better thought of as the Sarcophagus plan:

The letter attached signed by Sarkozy and Merkel appears to contain the details of the new measures addressed to EU President Herman van Rompuy.

“Mr President,

To overcome the current crisis, all necessary measures to stabilize the euro area
as a whole will have to be taken. We are confident that we will succeed.

We are convinced that we need to reinforce the architecture of Economic and
Monetary Union going beyond the indispensable measures which are urgently
needed to cope with immediate crisis resolution. Those steps need to be taken
now without further delay. We consider this as a matter of necessity, credibility and
confidence in the future of Economic and Monetary Union.

The current crisis has uncovered the deficiencies in the construction of EMU
mercilessly. We need to remedy those deficiencies. To build a lasting Stability and
Growth Union which allows us to preserve our unique European model combining
economic success and social responsibility, we have to substantially reinforce
the foundations of EMU. Alongside the single currency, a strong economic pillar
is indispensable, building on enhanced governance to foster fiscal discipline as
well as stronger growth and enhanced competitiveness. In order to achieve these
objectives, we need a renewed contract between the Euro area Member States.
This conviction is the driving-force behind our proposal.

We need more binding and more ambitious rules and commitments for the Euro
area Member States. They should reflect that sharing a single currency means
sharing responsibility for the Euro area as a whole. They should pave the way for
a new quality of cooperation and integration within the Euro area.

We propose that those new rules and commitments should be enshrined in the
European Treaties as. Alternatively , the Member States whose currency is the
Euro will have to go ahead. In that case, we would ensure that those Member
States willing and able to do so would be able to join and the European institutions
would play an important role. We would also work towards bringing this new
agreement into the framework of the European Union as soon as possible.

The main building blocks of the new Stability and Growth Union are:

A strengthened institutional architecture

Euro area governance needs to be substantially reinforced. We should provide for
a more integrated and more efficient institutional set-up without duplicating existing
European structures or institutions. This set-up should be based on:

•Regular summits – at least twice a year – of the Euro area heads of State
and Government with a permanent president. These summits will provide
strategic orientations on the economic and fiscal policies in the euro area.
The impact of our domestic economic and fiscal policies on the euro area
should be considered as a matter of common interest, while safeguarding
national responsibility.
• During the crisis, the Eurosummit should meet on a monthly basis: each
meeting should focus on a precise agenda regarding governance and
policies to foster growth, competitiveness and fiscal stability. Member
States having signed the Euro Plus Pact will be invited to participate to the
discussions on issues related to it.

• A ministerial Eurogroup and a reinforced preparatory structure to prepare
and implement the decisions taken by the summit and ensuring the current
functioning.

This framework will be fully consistent with the EU institutional architecture. We
strongly reaffirm our willingness to fully associate the European Commission.
The European Parliament and national Parliaments should also be involved in an
adequate way.

A comprehensive framework of prevention

It is undoubtedly in the interest of all members of the Stability and Growth Union to
detect and correct departures from sound economic and fiscal policies long before
they become a threat to the stability of the Euro area as a whole. Therefore, we
need a comprehensive framework on prevention consisting of strengthened co-
ordination, surveillance and enforcement as well as positive incentives, building
on current arrangements (new macroeconomic imbalances procedure, EU 2020-
Strategy, Euro Plus Pact, a greater focus of structural- and cohesion funds on
competitiveness etc.) and developing them further.

This framework should comprise in particular:

the adoption by each euro area member state of rules on a balanced
budget translating the objectives and requirements of the Stability and
Growth Pact into national legislation at constitutional or equivalent level.
A new legal provison should set minimum requirements for the national
rules on balanced budgets. The European Court of Justice, on request of
the European Commission or a Euro area Member State, should have the
possibility to verify the transposition in the national legislation.

-

Commitment of national Parliaments to take into account recommendations
adopted at the European level on the conduct of economic and budgetary
policies.

-

We need to foster growth through greater competitiveness as well as greater
convergence of economic policies at least amongst Euro Area Member States.
To these aims, building on Article 136 and/or on enhanced cooperation, a new
common legal framework, fully consistent with the internal market, should be
established to allowing for faster progress in specific areas such as :
- Financial regulation;

24
…24

-3-

Labor markets;
Convergence and harmonisation of corporate tax base and creation of a
financial transaction tax;
Growth supporting policies and more efficient use of European funds in the
euro area.

-
-

-

A reinforced procedure to enforce sound fiscal policies

To complement the preventive arm of the Stability and Growth Pact and in
particular the goal to achieve a structurally balanced budget and ex-ante
examination of draft budgets, a new procedure should be established to correct
breaches of the 3 % deficit of GDP ceiling.

As soon as a Member State is recognized to be in breach with the 3 % ceiling
by the European Commission, there should be automatic consequences unless
the Eurogroup, acting by qualified majority, decides otherwise. Exceptional
circumstances should be taken into account:

-

The obligation for the Member State to conclude with the Commission and
approved by the Eurogroup by reversed qualified majority on behalf of the
other Member States, a „European Reform Partnership“ specifying the
concerned Euro area Member States’ fiscal and structural policy measures
to overcome its difficulties and assisting them in those efforts.

-

A sequence of interventions of increasing intensity into Euro area Member
States’ rights should be allowed as a focussed response to continued
infringement. Steps and sanctions proposed or recommended by the
Commission should be adopted by the Council unless a qualified majority of
the Euro area Member States decides otherwise.

Buiding on the provisions for a numerical benchmark for debt reduction in the “six-
pack” (1/20 rule), the procedure for debt reduction by Euro area Member States
with a public debt of more than 60 % of GDP needs to be enshrined in the new
treaty provisions.

A permanent crisis resolution mechanism

We will accelerate the setting of the permanent intergovernmental European
Stability Mechanism which should be effective in 2012 to better address any future
threats to the stability of the Eurozone as a whole, including through the risk of
contagion for other Euro area Member States, thus assisting them in situations of
emergency.

In order to maximize the efficiency of the ESM and its capacity to take decisions,
specific super majority rules (85 % of signed ECB-Capital) should be implemented.

As far as the private-sector involvement is concerned, the ESM treaty should be
revised to make clear that Greece required a unique and exceptional solution. We

34
…34

-4-

recall that all other Euro area Member States reaffirm their inflexible determination
to honour fully their own individual sovereign signature. A recital in the preamble
should clarify that the euro area will apply the IMF practice. As agreed, common
terms of reference on CACs shall be introduced in national legislations.

***

On the occasion of the 50th anniversary of the Treaties of Rome we reiterated
solemnly together with all Member States of the European Union our resolve
to protect the achievements of European unification for the good of future
generations. To this end, we committed ourselves to always renewing the political
shape of Europe in keeping with the times. It is in this spirit that we submit our
proposal to our European partners.

We are convinced that we need to act without delay. We need to take a decision
at our next European Council meeting in order to have the new treaty provisions
ready by march 2012.

Angela MERKEL

Nicolas SARKOZY”

Yes, the Germans are concerned that ECB bond buying and direct funding might be inflationary,
but there is something even more fundamental supporting their to objection to ECB support.

The problem is,
the EU leaders believe the high rates, failed auctions, and related funding and liquidity issues
are caused by the national government budget deficits being too high.

And therefore the fundamental solution is deficit reduction.
That is, only by reducing deficits,
will the ability to independently fund return to where it was before the 2008 financial crisis hit.

So while they recognize that ECB funding can keep them muddling through,
though with some perceived inflation risk,
they firmly believe it is deficit reduction that will allow them to return to pre 2008 funding dynamics,
where each member nation could independently fund itself in the market place at reasonable rates.

Unfortunately, that’s a bit like saying that by adjusting his financial ratios,
Bernie Madoff’s fund could return to pre crisis business as usual.

And just like Bernie could only be back in business if somehow he got
the Fed to guarantee his investors against loss,
the way I see it (but, unfortunately, not the way they see it),
the euro member nations now require ECB backing, directly or indirectly,
to be back in business.

As previously discussed, spending and deficits for currency issuers like the US, Japan, UK,
and the euro members when they had their own currencies are not constrained by income or
market forces. Observed debt to GDP levels for currency issuers can be anywhere from
50% to maybe 200%, as they serve to provide the net financial assets demanded by the
various institutional structures of those nations. And regardless of debt ratios, interest rates
are necessarily set by the Central Banks, and not market forces.

Spending and deficits for currency users, including the US states, businesses, households, and the euro member nations since
adopting the euro, are, however, necessarily constrained by income and market forces.
That’s why observed deficits for currency users are far lower than currency issuers.
California, for example, has seen its financing difficulties even though it’s debt to GDP ratio is under 5%.

Luxembourg’s debt to GDP ratio of about 15% when it adopted the euro was by far the lowest of the euro member nations.
And that’s because Luxembourg never did have it’s own currency. It was always a currency user,
and so market forces never let it’s debt get any higher than that. And even with the current financial crisis
Luxembourg’s debt is only about 20% of GDP.

So what happened about 13 lucky years ago is that the currency issuers of mainland Europe decided to turn themselves into currency users.
And at the same time, now as currency users rather than currency issuers,
simply waltz into the euro zone with their suddenly/absurdly too high existing debt ratios they incurred as currency issuers.

The ‘right’ way to do it back then would have been to have the ECB guarantee their debt from the inception of the euro,
and use the Growth and Stability Pact to avoid moral hazard issues and enforce compliance.
But that would not have worked politically.
The only way they would all come together is the way they did all come together.
The priority was union first, and work out subsequent problems as needed.

So now they have two problems-
a solvency problem where they can’t fund themselves without ECB support,
and a bad economy, now further deteriorating as evidenced by negative growth and rising unemployment.

And while the Germans aren’t entirely wrong in their belief that lower deficits would restore funding capacity,
I don’t think they recognize that as currency users debt to GDP ratios may need to be under 30% to get to that point.

Nor do they recognize that given current private sector credit conditions, deficits and debt ratios need to be higher
to offset the demand leakages (unspent income) inherent in their institutional structures. These include pension contributions,
insurance reserves, corporate reserves, individual retirement plans, and the demand for actual cash in circulation.
This means that what they call austerity- pro active tax increases and spending cuts- will slow the economy and therefore cause
tax revenue to fall and transfer payments to rise to the point where deficits increase rather than decrease.
The only remaining hope for growth is exports, but with all the world doing much the same that channel is not currently open.

So back to the present.

(And yes, without the 2008 financial crisis all of this may not yet have happened.
But it all did happen, and here we are.)

The firm belief is that deficit reduction is what is needed to return to independent funding.
And while funding by the ECB can allow things to muddle through, and hopefully not prove inflationary,
there is no exit from ECB funding and the inherent inflation risk it carries apart from deficit reduction.

Therefore I expect the upcoming discussions to focus entirely around deficit reduction, with little if any discussion of funding.
And, as is currently the case, funding assistance will only come conditionally with accelerated austerity.

That is, all options on the table will only cause a bad economy to get worse.
And all options on the table will tend to drive deficits higher,
which both makes matters worse, and,
as recent history has shown,
triggers demands for more austerity.

The chart, below, shows how the financial crisis of 2008 caused what seemed to be working just fine on the way up
to come apart when private sector credit expansion faltered, and the economy took a dive, driving up national government
debt to GDP ratios, and causing it all to go bad in typical ponzi fashion.

They seriously believe that the crisis is all about deficits being too high,
and it all will be and can only be remedied by bringing deficits down.

Therefore they see ECB funding as not solving anything if it doesn’t serve the further purpose of deficit reduction.

Good luck to them, and good luck to us as we’re trying to do the same thing.

:(

France, Germany to Propose New EU Treaty

Published: Monday, 5 Dec 2011 | 10:55 AM ET
By: Reuters with CNBC.com

 
France and Germany have agreed on a series of reforms to address the euro zone sovereign debt crisis that will be presented to EU President Herman Van Rompuy on Wednesday, French President Nicolas Sarkozy said after a meeting with German Chancellor Angela Merkel on Monday.

 
“Things cannot continue as they have done up until today. Our preference is for a treaty among the 27 (EU members), so that nobody feels excluded, but we are open to a treaty among the 17 (euro members), open to any state that wants to join us,” Sarkozy told a press conference following the meeting.

 
“This treaty would contain the following things: We want automatic sanctions in the event of a breach of the rule on deficits below 3 percent (of GDP),” he said.

 
“We want a golden rule that is reinforced and harmonized on the European level so that the budgets of all 17 (euro zone states) have a constitutional rule to ensure that national budgets move toward a return to equilibrium,” Sarkozy added.

 
The French President said the Franco-German agreement would be written up in a letter and presented to (European Council President) Herman Van Rompuy on Wednesday.

 
“We want to make sure that the imbalances which led to the situation in the euro zone today cannot happen again,” he said.

 
Angela Merkel stressed the leaders wanted structural changes which go beyond agreements.

 
“We need binding debt brakes, which can be verified by the European court of Justice … in order for the Stability and Growth Pact to hold,” she said.

 
The Stability and Growth pact lays out the budgetary rules that member states must follow.

 
Berlin and Paris are under unprecedented pressure to see eye to eye in a crisis that has split them on issues such as the role of the European Central Bank in lending to troubled states and on whether the bloc should issue joint euro bonds.

 
“Regarding what we have said about the ECB, nothing has changed. We reject the idea of euro bonds,” Merkel said.

“This package shows that we are absolutely determined to keep the euro as a stable currency and as an important contributor to European stability.”
Top ECB policymakers have been reluctant to buy up debt from distressed euro zone states, as this would take the pressure off governments to get their financial houses in order.

 
But ECB chief Mario Draghi has signaled that a “fiscal compact” produced by the euro zone governments could nudge the bank to act more decisively on the crisis.

 
The hope is that private bondholders will be assured that they are not being singled out by European policymakers for losses, bolstering their confidence in buying euro zone bonds.

 
On Monday, an ECB policymaker described a plan for holders of Greek government debt to take heavy losses had led to a big rise in borrowing costs for other euro zone countries.

 
“It was a terrible mistake,” said ECB Governing Council member Athanasios Orphanides, who is also the Cyprus central bank chief.

 
Cyprus banks are big holders of Greek government debt, the value of which is due to be halved under a new 130 billion euro bailout deal for Athens.

 
In Dublin, Ireland’s government will unveil what it hopes will be the toughest budget of its five-year term, but as it tries to keep the public onside economists are warning that a global downturn means the worst may be yet to come.

 
On Tuesday, the Greek parliament is due to give final approval to a draconian 2012 austerity budget that is a condition for a second bailout package still under negotiation with private creditors, euro zone governments and the IMF.

From the NY Times:

The leaders met over lunch at the Élysée Palace to prepare joint proposals to
offer the full membership the European Union in Brussels on Thursday night. They
agreed to propose automatic penalties for countries that exceed European deficit
limits as well as the creation of a monetary fund for Europe. They also backed
monthly meetings of European leaders.

Supporting suspicions it’s all for the further purpose of supporting their lifestyle…

Forwarded Message

From the WSJ:

“Ms. Merkel signalled on Friday that she is having second thoughts about the wisdom of emphasizing bondholder losses. “We have a draft for the ESM, which must be changed in the light of developments” in financial markets since the Greek-restructuring decision in July, she said after meeting Austria’s chancellor in Berlin.

 

Austrian Finance Minister Maria Fekter, speaking at a conference in Hamburg on Friday, was more direct. “Trust in government treasuries was so thoroughly destroyed by involving private sector investors in the debt relief that you have to wonder why anyone still buys government bonds at all,” Ms. Fekter said.”

In this crisis of ignorance
the only thing they all agree on
is austerity:

By Jurjen van de Pol
Dec. 2 (Bloomberg) — The Netherlands isn’t in favor of
monetary financing by the European Central Bank to combat the
region’s debt crisis as it may spur inflation and takes away
pressure to reform, Dutch Prime Minister Mark Rutte said.
“Countries that are now forced to reform may get the idea
that there’s no need to reform because the printing press has
been switched on,” Rutte told reporters after the weekly
council of ministers in The Hague today.

With the tools currently at their immediate disposal, including providing unlimited member bank liquidity,lowering the interbank rate, and buying euro national govt debt, the ECB has no chance of causing any monetary inflation, no matter how hard it might try. There just are no known channels, direct or indirect, in theory or practice, that connects those policies to the real economy. (Note that this is not to say that removing bank liquidity and national govt credit support wouldn’t be catastrophic. It’s a bit like engine oil. You need a gallon or two for the engine to run correctly, but further increasing the oil in the sump isn’t going to alter the engine’s performance.)

Lower rates sure doesn’t do the trick. Just look to Japan for going on two decades, the US going on 3 years, and the ECB’s low rate policies of recent years. There’s not a hint of monetary inflation/excess aggregate demand or inflationary currency weakness from low rates. If anything, seems to me the depressing effect on savers indicates low rates from the CB might even, ironically, promote deflation through the interest income channels, as the non govt sector is necessarily a net receiver of interest income when the govt is a net payer. (See Bernanke, Reinhart, and Sacks 2004 Fed paper on the fiscal effect of changes in interest rates.)

And if what’s called quantitative easing was inflationary, Japan would be hyperinflating by now, with the US not far behind. Nor is there any sign that the ECB’s buying of euro govt bonds has resulted in any kind of monetary inflation, as nothing but deflationary pressures continue to mount in that ongoing debt implosion. The reason there is no inflation from the ECB bond buying is because all it does is shift investor holdings from national govt debt to ECB balances, which changes nothing in the real economy.

Nor does bank liquidity provision have anything to do with monetary inflation, currency depreciation, or bank lending. As all monetary insiders know, bank lending is never reserve constrained. Constraints on banking come from regulation, including capital requirements and lending standards, and, of course credit worthy entities looking to borrow. With the ECB providing unlimited liquidity for the last several years, wouldn’t you think if there was going to be some kind of monetary problem it would have happened by now?

So the grand irony of the day is, that while there’s nothing the ECB can do to cause monetary inflation, even if it wanted to, the ECB, fearing inflation, holds back on the bond buying that would eliminate the national govt solvency risk but not halt the deflationary monetary forces currently in place.

So where does monetary inflation come from? Fiscal policy. The Weimar inflation was caused by deficit spending on the order of something like 50% of GDP to buy the foreign currencies demanded for war reparations. It was no surprise that selling that many German marks for foreign currencies in the market place drove the mark down as it did. In fact, when that policy finally ended, so did the inflation. And there was nothing the central bank could do with interest rates or buying and selling securities or anything else to stop the inflation caused by the massive deficit spending, just like today there is nothing the ECB can do to reverse the deflationary forces in place from the austerity measures.

So here we are, with the ECB demanding deflationary austerity from the member nations in return for the limited bond buying that has been sustaining some semblance of national govt solvency, not seeming to realize it can’t inflate with its monetary policy tools, even if it wanted to.

Post script:

The only way the ECB could inflate would be to buy dollars or other fx outright, which it doesn’t do even when it might want a weaker euro, as ideologically they want the euro to be the reserve currency, and not themselves build fx reserves that give the appearance of the euro being backed by fx.

The German 10 year just traded above 1.9%.
The 10th plague is now beginning to threaten the Pharaoh.

If I were cynical I’d think it would go down something like this:

First, German insiders give the nod to their cronies.
The Great European Relief Rally begins.
The euro begins to firm, stocks start to rally, etc.
Then, noises start coming out of Germany to the effect that
they might consider ECB support if austerity could be guaranteed,
causing prices to suddenly gap higher as shorts try to cover with no sellers in sight.

As previously discussed, there is virtually no political support to leave the euro,
as it’s not intuitively obvious the euro is the problem.

It is intuitively obvious, however, that the problem was irresponsible govt
and so the move towards responsible govt- aka austerity- continues.

The euro economy can be easily ‘fixed’ and in short order.
The ECB can, one way or another, facilitate all funding needs and end the solvency issue.
And the Stability and Growth Pact (SGP) can be modified to allow deficits sufficient to sustain aggregate demand.

Currently Germany continues to be obstructing the elimination of the solvency issue,
even as market forces are now begining to weaken German bonds.
And there are no member nations yet supporting readjusting the SGP to allow higher deficits.

So my best guess is Germany will soon recognize what most of the financial community has recently been voicing- ECB bond buying combined with austerity is not inflationary- opening the door to the ECB bond buying being an EU sanctioned policy of the institutional structure to ensure solvency.

That will trigger a massive ‘relief rally’ that will fade as the reality of the depressing nature of the
austerity takes over.

It could also sideline the discussion of Greek haircuts and default discussion in general.

Spanish Voters Set to Throw Out Socialists in Election

November 20 (Reuters) — Spaniards are expected to throw out the Socialists they blame for a disastrous economic situation in an election on Sunday and to vote in a center-right party likely to dole out more bitter medicine in the form of public spending cuts.

Opinion polls show the People’s Party (PP), led by Mariano Rajoy, has an unassailable lead over the ruling Socialists, who have led the country from boom to bust in seven years in power.

Voters are angry with the Socialists for failing to act swiftly to prevent the economic slide and then for bringing in austerity measures that have cut wages, benefits and jobs.

Yet people are now resigned to further slashes in spending on health and education in the midst of a European debt crisis that has toppled the governments of Ireland, Portugal, Greece and Italy and pushed Spain’s borrowing costs ever higher.

Occupy Brussels…

EU Staff Threaten Strike Action Over Belt-Tightening

BRUSSELS (AFP)–European Union staff unions on Friday threatened strike action next week to protest belt-tightening measures as the bloc goes on an austerity diet.

A statement from an “Inter-institutional Joint Front” representing the 55,000 staff across the European institutions has called an assembly on Tuesday following a breakdown in conciliation talks with the European Commission.

European staff wages vary widely: from EUR2,650 per month before tax and social welfare payments, to EUR23,000 gross for each of the 27 national EU commissioners.

Staff are concerned by a bid to overhaul staff rules and by a letter signed by 17 of the 27 EU states that criticizes automatic wage adjustments and links the possibility of wage hikes to the economic situation.

The 17 austerity-driven nations also say an increase in retirement age from 63 to 65 isn’t sufficient.

Staff unions on the other hand criticize working conditions on their Facebook page

In this case default = EU sanctioned debt forgiveness,
which, at this point in time, only reinforces the notion that
no one with any fiduciary responsibility should be buying any euro member debt.

This shortens the time frame between now and when things get bad enough for
Germany to permit the ECB to do what it takes to get past the national govt solvency issue.

Germany confirms it is considering more eurozone “orderly defaults”

Berlin/Brussels (DPA) — The German Foreign Ministry on Friday confirmed that Germany was considering the possibility of more eurozone “orderly defaults” beyond that of Greece, as suggested by a paper leaked by the British press.

The Daily Telegraph published a six-page document, attributed to the Foreign Ministry, suggesting that partial bankruptcy must be made possible for all euro members “unable to achieve debt sustainability.”

“There must also be the option of an orderly default (of a struggling euro member) to reduce the burden on taxpayers” in other eurozone members which are paying for its bailout, the document said.

“There is nothing secret about it,” the ministry said Friday, stressing that it contained ideas on which Foreign Minister Guido Westerwelle had already publicly commented upon.

At the start of the euro debt crisis, EU leaders maintained that no country would ever fail to pay back debts. This year the taboo was broken with Greece, as private lenders were ordered to take a 21 per cent hair cut on Greek bonds. The figure was then raised to 50 per cent.

The memo proposed that “orderly default” procedures should be governed by the European Stability Mechanism, the new euro rescue fund which, under current plans, is due to enter into operation in 2013.

The paper also backed strong EU interference in the economic affairs of eurozone budget sinners, proposing that a country not meeting austerity targets could “have concrete budgetary measures imposed upon it,” such as “specific spending cuts” or new taxes.

But commenting on Dutch proposals to create an EU commissioner with direct powers of intervention in national budgetary policies, it warned that “the constitutional provisions on the budgetary autonomy of the Bundestag (German parliament) must be observed in every case.”

Recalling well-known German positions, the document called for EU treaty changes to implement the budget discipline reforms it advocated, which also include the possible freezing of EU regional aid and taking budget sinners before the EU Court of Justice.

But it also accepted that such course of action may not be possible.

“In case (an EU treaty change) is not politically feasible, an alternative treaty between the member states that is legitimate under international law ought to be considered,” it said.

Good to see Dirk at Goldman is pretty much spot on:

German Economic Commentary : Chancellor Merkel not keen on more a proactive ECB stance

Published November 18, 2011

Chancellor Merkel gave a speech in Berlin yesterday where her main message with respect to stabilisation measures was essentially: No! Merkel rejected the introduction of Eurobonds but also any commitment from the ECB’s side to be the lender of last resort for Euro-zone governments.

There are several arguments the German government/Bundesbank are putting forward against a more pro-active stance of the ECB. First, a more pro-active role would not be in accordance with the treaties. Second, it would create moral hazard as it would reduce the incentive for governments to consolidate and reform. Third, debt monetisation, sovereign debt purchases by the ECB, leads to inflation. The latter argument was echoed by the chairman of the council of economic experts Franz, who said in an interview with FAZ newspaper that debt monetisation is a “deadly sin” for a central bank.

These are valid arguments, but only up to a point. In particular the worries about the inflationary impact of debt monetisation are exaggerated. Sovereign debt purchases of a central bank do not necessarily lead to inflation (see the example of Japan, although it can, see the example of Zimbabwe). It can lead to inflation if these purchases are used to finance an expansionary fiscal policy that will lead to strong growth and demand outpacing supply such that price setters will increase their prices. Fiscal policy, however, will be quite restrictive in the Euro-zone in the coming years. Italy, for example, aims at tightening fiscal policy by almost 3% next year on our estimate (we calculate this as the change in the structural primary fiscal balance). And while it remains to be seen whether the fiscal targets will be met, it is a safe bet that fiscal policy will not be expansionary in the Euro-zone for quite some time.

It can also lead to inflation if there is an excessive debt overhang, i.e. the fiscal position of a country is clearly unsustainable. Put differently the expansion of the monetary side is, even in the long run, not backed by a similar expansion of the real side of the economy. As we have argued in the past we see this only as a remote risk.

What the ECB is currently doing under its SMP is essentially swapping one savings instrument (peripheral sovereign debt) for another (cash) as private sector investors, for various reasons, no longer want to hold peripheral debt. But this has no inflationary implications unless one assumes that investors are spending the cash thereby stimulating demand which then leads to inflation. But these investors are not holding cash because they want to increase their spending, but because they think, rightly or wrongly, that cash is more rewarding from an investment point of view.

There are no easy choices and it would have been, no doubt, better if the ECB had never got in the position it is in now. But the current situation demands a careful weighing of the risk involved with any decision taken. The inflationary risk thereby seems to be getting an unduly high weight in the consideration of German policy makers.

Dirk Schumacher