One of the problems of the Eurozone has been that the nations do not have the right to issue the currency in which they borrow. That leads to an instability of sovereign debt that is not felt by the U.S., U.K. or Japan, all of which issue sovereign debt in their own currencies.
The expansion of the ECB balance sheet is in process of ameliorating that problem because the ECB does have the right to create euros. For this reason, worries about the ECB’s solvency are overblown.
Combine the ECB’s expanding balance sheet (it will expand more) with the ECB’s extraordinary role in the amendments to the Treaty that are being negotiated to strengthen the fiscal union and one sees a central bank not only independent, but also deeply involved in influencing the politics of the region. Because the ECB is not only the lender of last resort but also the only hope of the Zone’s leaders to bring order to the economic chaos of the last two years, the leaders must listen to the ECB’s demands for greater central control of member nations’ finances.
The tail is wagging the dog, some may say. Unelected leaders are commanding elected leaders to toe their line, others may say. The Brussels/Frankfurt nanny state is expanding is reach, still others may say. And on and on. But no matter. The fact is that since Mario Draghi took over the ECB, the entire tone of Europe has changed for the better. Italy and Spain are adopting measures to restructure their economies and they are holding successful bond auctions, most banks have been liquefied, and, although economies have slowed, that was in the works before November 1. Yes, banks have parked almost 500 billion euros at the central bank, indicating caution, but that money also is available for banks to lend when they gain enough confidence to do so. That is far better than banks being unable to obtain money at all.
It is ironic that S&P has picked this week, when the economic climate actually has improved over six months ago, to downgrade several European countries’ sovereign debt. Frankly, that is more a comment on S&P’s failed model for rating sovereign debt than anything else. S&P and the other rating agencies started by rating corporate debt. They still may be good at that. But they showed they were not good at rating packages of loans, and they are now showing that they do not understand sovereign debt, either. As an investor, one has to pay attention to the downgrades because they can affect pricing. But longer term, the ratings should be regarded as irrelevant. The real question is whether the entity that has the power to create money stands behind the debt. And the ECB now has shown that it will defend the currency bloc—meaning the countries within it that play by its rules.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.