In the graph below, you can see the situation in Europe today. The graph traces the changes in the ECB's balance sheet since its creation. Stable at around €800bn from 2000 to 2004, it began to increase gradually until 2008, when it exploded to €2 trillion, following the Lehman Brothers bankruptcy and the ensuing implementation of emergency liquidity measures.
After falling back to €1.7T - €1.8T as healthy banks sought less aid, it shot right past its earlier highs to hit a new peak of €2.098T for the week of 6 June 2010. The payment of the €440bn 1-year long-term refi operation, which is about to come to term, will undoubtedly reduce the balance sheet again, but I have a hard time seeing the ECB offer an alternative solution, given the current stress levels on interbank markets.
In any case, aside from the Securities Markets Programme's masquerade of weekly sterilizations, our core scenario remains that of a much larger scale programme than that of the €60bn covered bonds. Not only is this clearly needed to accompany the European Financial Stability Fund, but it is vital to the eurozone's efforts to avoid falling into the dreaded Debt Deflation Trap. Such an eventuality is inevitable if today's German-style austerity plans spread (Martin Wolf contra the Pain Caucus, Bradford Delong), as some people (‘Fear must not blind us to deflation’s dangers’, Martin Wolf) are just now beginning to understand.
ECB balance sheet
And the quantity of money is not scary? (Click to enlarge)
And yet, we have been treated to cries of bloody murder from ECB members who continue to cling to the renowned Quantity Money Theory where the V in MV=PT is considered stable over time! Events have proven wrong the foundations of this Malthusian theory of the major aggregates, which undoubtedly explains the haggard state of our Great Moneyman. Since I am by nature an optimist, I will go even further.
Unfortunately, we will not be so lucky as to see Mr Noyer succeed Mr T as head of the ECB in 2011. Even with Mr Sarkozy's help, that bullet would be too big for the German Chancellor to bite, who must have quite a bit of lead in her stomach as it is. We will therefore probably be served up Mr Weber, who has the distinction of having been systemically wrong these past five years on the real state of the economy.
After proving too lax as he missed out on what was really going on with German banks (No BAFIN-BUBA communications) and too austerity-oriented after failing to realize the death of securitisation's implications on the velocity of money, Weber continues to argue for wrong-head monetary policy, like the ECB's historic mistake of July 2008 when it hiked rates in the midst of the crisis!
But now I see a ray of hope.
After all, his boring tirades about the harmful effects of the SMP could be just political posturing meant to ensure his election as head of the ECB so that, like the Chinese Communist Party, he can later apply the opposite policy as part of what will become a dual mandate, like in the United States? I can dream, can't I?
Asset allocation biases and advised option strategies
- The long-term macro biases remain downward on eurozone government yields and negative on risky assets (equities, European real estate, commodities) and a deflation/depression scenario, which will require much more effort by the ECB than a shame-faced QE
- Our short-term biases remain neutral. Sorry.
We continue to flirt with the idea of betting on a tactical rebound of about ten Eurostoxx indices, accompanied by a narrowing of sovereign debt spreads, which would lead to a 2-point decline on the Bund. But for that, the ECB will have to really take charge. Its €5.5bn in bond purchases last week are really pitiful.
Disclosure: Long 20 years OAT and 30 years BTP Zero Coupons, EDF Corp 5 Years 4.5%, Grece 2 Y and 10 Y bonds
