With respect to the eurozone peripheral nations, I find the continuing contrast between interest rate spreads (25% on 2-year Greek debt!) and the self-congratulatory comments by ECB board members, like that of Mr. Orphanides this morning, to be absolutely frightening:·
"It will not be necessary for the ECB to intervene to the same extent" in the bond market "to ensure the transmission of the monetary policy."
As readers may recall, the ECB refused to explain what it meant by "restoring the channels of monetary policy" when it set up the Securities Market Programme (SMP) in May 2010. However, such an evasion should surprise no one since the ECB allowed itself the luxury of stating a few days later that it had not even discussed the matter of turbulence on PIGS debt markets at their earlier meeting.
At the time, we pointed out that the damage caused by such semantic acrobatics -- considering the importance of a central bank's credibility factor (see at the end of today's note links to studies on the matter) and thus of inflation expectations, so we will not rehash the matter again today.
But if you check out how the ECB defines this SMP on its own website, it raises a few questions:
Securities Markets Programme
"Interventions by the Eurosystem in public and private debt securities markets in the euro area to ensure depth and liquidity in those market segments that are dysfunctional. The objective is to restore an appropriate monetary policy transmission mechanism, and thus the effective conduct of monetary policy oriented towards price stability in the medium term."
So let's do a little qualitative analysis of these commitments to help us understand why ECB members continuously repeat that it has met its goals.
This is how the spreads of the three peripheral nations plus Spain have evolved on 10-year maturities since the SMP's establishment.
Interest rate spreads of peripheral nations vs. the Bund
Right, a whole lot better.
Let's get serious!
Between the start-up of the SMP, which led to a temporary reduction in spreads to "reasonable" levels, and today (nearly a year later), interest rate spreads on Greek debt have increased from +430 bps to +1304 bps, Irish debt from +164 bps to + 734 bps, Portuguese from +164 bps to + 640 bps, and Spanish, the last rampart according to many, from +97 bps to +225 bps! And I am leaving aside 2 to 5 year debt; in the case of Greece, rates on 2-year debt are now at 25%.
Investors have no faith in the ECB's credibility or its actions, and neither do they put much credence in the promises of various European leaders that they will not restructure the debt of distressed peripheral nation economies!
We might even point out the setting aside of of the SMP in recent weeks has only heightened fears, as investors legitimately wonder if the fact that the ECB is no longer buying such high-yield instruments suggests that it is also looking for debt restructuring in the near future.
Given such pitiful results, we are astonished to see ECB members patting each other so contentedly on the back.
Who are they trying to kid with their assertion that dysfunctional markets have become liquid and deep? As one of my clients likes to say, what a joke!
Some may counter (thanks to a heavy dosage of bad faith) that we must look elsewhere for the ECB's success, and that thanks to the vigorous action of their SMP, it has restored the monetary policy transmission mechanism. The fact that the ECB never bothered explaining what it meant indeed leaves the door open to a plethora of interpretations, as we saw with Mr Orphanides (what a disappointment!), quoted at the beginning of this report.
Unfortunately, unless I am mistaken, in Europe, banks are the ones which mainly transmit monetary policy. And for all those with their fingers in the interbank market, where banks are supposed to obtain the reserves required to make loans to the real economy, the picture is hardly rosy.
It is true that the major banks with solid balance sheets are indeed lending to each other more easily than a year ago. But markets have become totally re-nationalised, which is pretty incredible consider that the euro's launch was supposed to create a huge monetary and financial market capable of competing with its rival in the U.S.! And entire category of banks suspected of having weak balance sheets, notably in the peripheral countries, are simply excluded from the market.
Moreover, the downgrading of the credit rating of these peripheral nations means that commercial banks with such paper in their balance sheets are required to raise much more capital than before; I am told, up to four times as much. Consequently, the capital thus raised can no longer be used to make loans to the real economy.
That really is "some success."
To wrap up, the ECB's credit report, published this morning, says it better than I could:
THE EURO AREA BANK LENDING SURVEY (emphasis mine)
According to the April 2011 BLS results, euro area banks generally tightened their credit standards in the first quarter of 2011, albeit moderately, on loans to both non-financial corporations (NFCs) and households. Looking ahead, euro area banks expect a further moderate tightening of credit standards for both NFCs and households in the second quarter of the year.
In contrast to the previous survey round, this move was mainly driven by banks’ credit supply-side considerations related to access to market financing and by their liquidity positions. Other factors that contributed to the moderate tightening were perceptions about risks and the overall economic situation.
Wow! Perhaps that's what they mean by restoring the monetary policy transmission channel; I would've never guessed.
Despite the preceding remarks about the SMPS and the exaggerated claims of its success, I am not suggesting that the ECB launch a full scale battle of the spreads. Rare as it may be, I am on exactly the same page as them on this question.
It is up to governments themselves to resolve the current systemic problems, which they are fully capable of doing, by applying the sort of conditions used in the AIG bail-out, as I have argued repeatedly in these lines.
That said, it would be so much better if the ECB were to explain clearly the reasons for its absence from this field, for once, based on valid motives.
How sad that it did not seize the occasion to recover some of the credibility lost since July 2008.
Links to central bank studies on the credibility factor:
- Central Bank Behavior and Credibility, The Federal Reserve Bank of St. Louis
- Central Bank Independence and Disinflationary Credibility: A Missing Link?, The Federal Reserve Bank of St. Louis.
- Central Bank Credibility, The Federal Reserve Bank of Cleveland.
- Central Bank Credibility and Consistency, Bradford-Delong.
- Central Bank’s Reputation and Credibility, The Bank Of Thailand.
- Central Bank Credibility and Monetary Policy, Indonesia.
- Crédibilité de la Politique Monétaire de la BEAC, Afrique.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Long 20 years OAT and 30 years BTP Zero Coupons, EDF Corp 5 Years 4.5%, Grece 2Y and 10Y bonds