When Steve Liesman of CNBC admits that he has been looking into the inner workings of the ECB for ten years and still does not get it, I believe him. I have been reading scores on the subject, and it is quite confusing. I have also received many questions on my articles referring to the subject, so I thought a little homework was is order. Don’t get me wrong, I too am confused, but here is what I found.
To start with, there are four acronyms to remember:
- The ECB, for European Central Bank, based in Frankfurt am Main in Germany. Dutchman Wim Duisenberg was its highly respected first president, from 1998 to 2003. Jean-Claude Trichet, from France, is its current president. Anecdotally, I must recall that Trichet’s appointment was delayed until he was cleared from fraud charges in connection with the collapse of the largest French bank at the time, Credit Lyonnais. He is to be replaced by the current governor of the bank of Italy, Mario Draghi. The ECB administers the monetary policy of the 17 states that have adopted the euro, called the eurozone members.
- The ESCB, for European System of Central Banks. It is comprised of the ECB and the 27 National Central Banks (NCBs) of all 27 European Union member states. Note: The 10 countries members of the EU but not of the eurozone are not ruled by the ECB: UK, Denmark, Sweden, Bulgaria, Czech Republic, Hungary, Poland, Latvia, Lithuania, Romania.
- The NCBs, for National Central Banks of each country. This is where it becomes complex. In the US, we have twelve Federal Reserve Districts which each monitor a few states. Except for state and local tax laws, all states are under the same federal tax code. So, while each state bears the liability of its own debt, some $2.7 trillion last I looked, the Treasury bears the liability of the federal debt, with the added guarantee of the 14th Amendment. States do not have the ability to print money. This is the main glitch in Europe, and a huge one. NCBs can issue debt, called sovereign debt, but they cannot print money, at least for those in the eurozone. The ECB can print money for them, but only to the extent of their share in the ECB (shortcut).
- The MFIs, for Monetary and Financial Institutions. These are all the financial institutions of the EU, with statistics distinguishing between those of the eurozone and those outside of it.
The reason why this is confusing is kind of simple, when you have assimilated all of the above. In this country, the Fed buys securities. Simple. In Europe – and I am not joking - this is an obtuse exercise, for lack of better words. The NCB borrows from the ECB through a repo – the ECB gives the NCB the cash, the NCB will give it back later. With the cash, the NCB buys a sovereign or other qualifying debt in trouble. This has increased the money supply, something the Germans are agonizing over. So, to “sterilize” the potential inflationary consequence, the NCB enters a reverse repo with the ECB – the NCB lends the cash back. This has been called the Securities Market Program, and I quote:
Securities Market Program (SMP):
On 10 May 2010, the central banks of the Eurosystem started purchasing securities in the context of the Securities Markets Programme (SMP), with a view to addressing the severe tensions in certain market segments which have been hampering the monetary policy transmission mechanism. Under the SMP, public and private debt securities are considered eligible for purchase.
With a view to leaving liquidity conditions unaffected by the programme, the Eurosystem re-absorbs the liquidity provided through the SMP by means of weekly liquidity-absorbing operations. The intended amount for absorption equals the cumulative size of settled SMP transactions at the end of the preceding week, rounded to the nearest half billion.
Amount outstanding as of August 8, 2011 = E 74 bn.
There is much more to the story, but it’s late on Sunday and I have a few kids to enjoy so I will leave to this.
As far as the market is concerned, I am fairly satisfied with my objectives having been met. I sense that sentiment is changing a bit too fast. I would like S&P 1150 to be tested again, maybe just one more time, but this may be finagling. The one thing that intrigues me: Why did we triple bottom at 1120? I can understand the intraday low of 1100, but 1120? In any case, here is a chart with some Fibonacci levels (click to enlarge image). If 1150 holds next week, this will qualify as the second best bottom I have seen in a long time.