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Christopher Mahoney
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I spent eight years at Bank of America in New York (1978-86) covering Wall Street, then moved to Moody's Investors Service where I worked for 22 years, covering banks, sovereigns and corporates. I chaired the Credit Policy Committee for four years. I retired in 2007 as vice chairman.
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  • The ECB Can Easily Save The Eurozone 2 comments
    Jul 7, 2012 1:42 PM

    As a thought-experiment, let's imagine that Germany decides to permit (or is forced to permit) a monetary rescue of the eurozone, as opposed to a fiscal (eurobond) approach.

    There is a rate of inflation (perhaps 8-10%?) that will allow the PIIGS's to close their budget gaps, as nominal revenues race ahead of expense. So the PIIGS will be in surplus and their debt/GDP ratios will start to decline. Additionally, the euro will weaken in the foreign exchange markets, which will improve the current account positions of the PIIGS as well. That's a pretty good start.

    Let's also say that the ECB stands ready to refinance the maturing debt of eurozone members based upon certain fiscal criteria and at various risk-adjusted interest rates (which are lower than current market rates). This will expand the ECB's balance sheet, perhaps at the desired rate or perhaps above it. To the extent that the ECB's asset growth exceeds the targeted rate of inflation, it can sterilize its purchases by selling "ECB bonds" to the public (just as the Fed can sterilize purchases of agency MBS by selling Treasuries). Investors replace their risky government bonds with "riskless" ECB bonds (riskless, because the ECB prints euros).

    This would mean that not only would the PIIGS be in surplus with declining debt ratios, but also that they would no longer face refinancing risk. Crisis over. And not only would Germany not have to bail out anyone, it's own creditworthiness would improve as well (at the expense of its credulous bondholders).

    Frankly, I can't imagine a better outcome for all. Europe would immediately enjoy nominal growth, followed by real growth as confidence and investment return. Just as inflation is always and everywhere a monetary phenomenon, so is nominal growth. If the Bank of Italy can manage it, so can the ECB.

    The costs of this strategy are that price stability is sacrificed for growth, and holders of low-yielding euro-denominated bonds will suffer. The sacred "credibility of the euro", so near and dear to the Germans, will be shattered forever. It might even become, temporarily, a "high yield currency". A weak euro with volatile inflation will theoretically raise the risk-free real rate of interest in the eurozone.

    But why do modern central banks exist? Don't the reasons include (1) preventing financial collapse, and (2) preventing depressions? If so, Germany will have to discard the "hard euro" shibboleth, and accept what the US has already done, which is dual mandates of low inflation plus growth. Hyperinflation is an extremely destructive and inequitable event, but that is not what is recommended. What is recommended is inflation such as the world experienced in the 1970s, which did not end Western civilization.

    Everything that I have written above is already in Mario Draghi's mind. The problem is that it will take much more dislocation and distress to force Germany to permit the ECB to "go wild". They are wedded to the hard euro and to the single mandate. So in the end they will have to choose between a Mediterranean monetary policy or a Mediterranean economic collapse. Please pick one.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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Comments (2)
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  • praveenbhargava
    , contributor
    Comments (81) | Send Message
    "Rescue operation for PIIGS Nations",this is the talk of the town.Tell me for how long?No one is giving any encouraging news such as signs of growth,improvement in employment numbers,increase in manufacturing numbers,Reduction in bank's NPA ratio,Comfort for the investment climate in whole of Euro-Zone.How long this process of saving the PIIGS Nations from Debt default and/or bank failures will continue?
    Actually all the efforts made by ECB to save and/or improve the PIIGS Nations economy are somehow failed to achieve the desired improved is now going on for the last 3 years or so with less improvement and/or no improvement.The economic situation in Euro Zone is deteriorating day by day and it is now on the verge of collapse. Time is very near for full fledged recession in Euro-Zone and likely to spread in USA as well as other Asian countries soon.
    7 Jul 2012, 02:42 PM Reply Like
  • Christopher Mahoney
    , contributor
    Comments (1314) | Send Message
    Author’s reply » I agree. Time is running out.
    9 Jul 2012, 11:55 PM Reply Like
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