The cries heard around the world for the ECB to put an end to the sovereign debt crisis in Europe by aggressively purchasing the sovereign bonds of nations such as Italy, Portugal and Spain have become deafening.
Finance ministers and heads of state from nations as diverse as Great Britain, Portugal, Russia, Italy and the United States have expressed their growing exasperation with ECB reticence to contain a crisis that threatens to throw the entire global financial system and economy into a tailspin.
Many financial commentators have taken the view that since the consequences of inaction would be so dire, the ECB will inevitably relent.
The problem is that most of these pundits have not been listening carefully to what members of the ECB itself are saying. At the very least, they are not taking their statements seriously, believing that hawkish statements are mere posturing to give an appearance of central bank independence and also to pressure member states to implement reforms.
In this regard, U.S. pundits are committing a grave error by projecting their own opinions and biases onto ECB committee members that are faced with a set of legal, political and cultural constraints that simply do not exist in the U.S.
What ECB Members Are Actually Saying
Jose Manuel Gonzalez-Paramo is generally regarded as a spokesman for the consensus within the six-member Executive Committee of the ECB. Gonzalez-Paramo has stated in no uncertain terms that the ECB is a lender of last resort for banks, but not for governments. He has stated that it is not the role of the ECB to solve Europe’s sovereign debt crisis. According to Gonzalez-Paramo, the role of the ECB is to fight inflation and deliver price stability.
Asked about the ECB's bond purchases and Italian troubles, Paramo said that the ECB is not the lender of last resort and that, “we mustn't forget that the creation of money, over time, results in inflation. And the ECB sterilizes every euro of bond purchases. The Italian problems are, above all, Italy's, and they are going to resolve these themselves."
Gonzalez-Paramo sounds positively dovish compared to the two Germans on the ECB Governing Council.
Executive Committee member Juergen Stark has been conducting a very aggressive public relations campaign to preempt any public pressure for the ECB to engage in quantitative easing.
To cite just one example, Stark warned European governments on Wednesday against asking the ECB for support in dealing with the region's sovereign debt crisis,.
"We are not the lender of last resort (to governments) and I do not advise European governments to ask the ECB to become lender of last resort," Stark, a member of the European Central Bank's Executive Board, told a business conference.
"This will mean that the ECB immediately will lose its independence," Stark said.
"Exactly this is the reason why the ECB is so respected: it does not have the mandate the Federal Reserve does. We have a primary goal, we have a clear cut mandate, one objective ... to deliver price stability over the medium term," Stark said.
Stark went even further and took the liberty of speaking for the other members of the 23-member governing council: "I think I speak on behalf of my colleagues on the Governing Council, we will not ask and we will refuse to have an extension of the mandate for the ECB to become lender of last resort to governments."
Indeed, Stark is so adamant in his opposition to ECB bond purchases that he has resigned from the ECB in protest against the timid bond-buying measures that the ECB has engaged in so far. Stark’s resignation will be effective in early 2012 as soon as another German takes his place.
And make no mistake: The Germans will nominate a candidate that is at least as fanatical as Stark to take his place.
If there is any doubts about this, readers should recall the earlier resignation of Axel Weber from the ECB Governing Council protesting the same bond-buying policy adopted by the ECB. The Germans have replaced him with Jens Weidmann, a man that has proven himself to be at least as rigid in this regard as his predecessor.
In fact, Weidmann has recently upped the stakes in the debate surrounding ECB purchases of sovereign debt by categorizing such actions as not only wrong-headed, but illegal. Weidmann firmly rebuffed calls for the ECB to intervene in the sovereign debt crisis stating that such intervention would create even more instability by violating European laws against “monetary financing” (i.e. central bank funding of governments). “I cannot see how you can ensure the stability of a monetary union by violating its legal provisions,” Mr Weidmann argued. “I don’t see how you can build trust in a system that violates laws.”
Will Super Mario Save The Day?
Many financial markets commentators have pinned their hopes on Mario Draghi (known as “Super Mario” in Italy), the newly elected President of the ECB. The thought is – hope is probably a better word -- that Draghi will not be as rigid as his predecessor Jean Claude Trichet. with regards to QE-style bond purchases.
There is much in Draghi’s background to suggest that he is not a rigid ideologue. His US-based education and his various academic and professional affiliations paint a picture of a pragmatic outlook.
The problem is that in order to be where he is, Draghi has had to toe the German line very closely. Indeed, to secure the ECB presidency Draghi had to engage in an aggressive public relations campaign in Germany in which he attempted to convince the Germans that he was more “German” in his monetary views than the Germans themselves. He succeeded.
Draghi’s successful PR campaign culminated with a key public endorsement by Bild, Germany’s most powerful and most popular conservative newspaper. This was stunning reversal given that the newspaper had originally vehemently opposed Draghi’s candidacy. The newspaper had previously argued: “Mamma mia, with Italians, inflation is a way of life, like tomato sauce with spaghetti.” Despite this initial visceral opposition, Draghi mangaged to convice the Germans that he was more of a papist than the pope himself – to borrow an expression used in several Romance languages. So successful was Draghi in this PR campaign that the Bild published a photographic montage of Mr Draghi wearing a spiked Prussian helmet and the headline: “The new ECB chief is so German.” The newspaper report containing the endorsement concluded that, “it is clear that he’s rather German, indeed, a proper Prussian.”
Under such circumstances, Draghi is highly unlikely to betray his German benefactors, so soon after he made so many promises to them in order to gain their support.
Any doubts along those lines should be dispelled by fellow Executive Committee member Jose Manuel Gonzalez Paramo, who told Spanish newspaper El Pais recently that the world “must expect continuity… The mandate of the bank continues to be the same.”
When confronted with the issue since becoming president, Draghi has been very clear that the bond purchasing program must be quickly brought to a close since it is his view being a lender of last resort to governments is not part of the ECB's institutional mandate.
Conclusion
Most financial market pundits in the United States have been projecting their own opinion and biases upon the ECB. The prevailing view is that given the dire alternatives, the ECB has no choice but to monetize PIIGS debt.
This sort of projection represents a fundamental error.
Analysts need to listen more to what ECB members are actually saying and understand the legal, political and cultural structures that constrain the members of this institution.
Key members of the ECB Governing Council have taken a radically hard stance against ECB debt purchases. The Germans in particular have painted themselves into a corner that is going to be extremely difficult to get out of. The Germans within the ECB have whipped up a nationalist furor over this issue and they have now made it virtually impossible for themselves to reverse course. Furthermore, without German consent, it is virtually inconceivable that the ECB will go forward with sovereign bond purchases on a scale that would be sufficient to prevent a full-fledged sovereign bond crisis.
Having said all of this, it remains my view that the Germans will eventually relent and that the ECB will eventually go on a debt-buying spree. However, it is my view that they will not do this until the crisis has become so acute that the Germans themselves are feeling the pain of financial crisis, recession and significantly higher unemployment.
By that point equity markets around the world will have collapsed below recent lows set in early October.
I will repeat here what I have been saying consistently for several weeks: My target zone for the S&P 500 (SPX) based on the scenario laid out above is 950-1,020. In my view, all but the shortest-term traders should refrain from attempting to play the equity market on the long side through individual stocks or equity market proxies such as SPDR S&P 500 ETF Trust (SPY), SPDR Dow Jones Industrial Average ETF Trust (DIA) or Powershares Nasdaq-100 Index Trust (QQQ). I believe that investors with longer time horizons should raise cash and avoid purchasing or holding otherwise attractive equities such as Apple (AAPL), Microsoft (MSFT) and Pepsi (PEP).
Disclosure: I am long puts on a variety of cyclically sensitive equity indices. I am also short QQQ. I am short TLT.
