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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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  • ECB: Bundesbank Wins, Europe Loses 0 comments
    Aug 2, 2012 11:36 PM

    Readers know that I had expected the Bundesbank to throw some bones to Draghi so that he could save face at today's ECB board meeting. As far as I can tell, they gave him almost nothing. I had thought that he would be allowed to cut the overnight rate, offer a new low-cost bank loan program, and engage in bond-buying for "monetary reasons".

    What they allowed him to say was that, if and when countries conclude austerity agreements with the Troika, then the ECB would be willing to buy government bonds in the secondary market in order to bring yields down. This is almost nothing. What Europe must have now is (1) massive quantitative easing in order to create inflation and grow nominal GDP; and (2) unconditional purchases of Spanish and Italian bonds until their yields are driven down to affordable levels. No more conditions, no more austerity. (That can be addressed after the crisis has been defused.)

    Clearly, the Bundesbank drafted the ECB's press release. It prescribes a full-fledged examination by the Troika in classic IMF style, imposition of a Troika-designed austerity plan that would not only cut budgets and raise taxes, but also require labor market and other structural reforms. As we have seen elsewhere, such programs are highly detailed and require a complete loss of sovereignty, something that both Spain and Italy have strongly resisted.

    Instead of rescue by ECB printing press, Germany continues to offer rescue by draconian thrift, which the Italian and Spanish political systems are incapable of delivering. Neither country has any hope of being able to perform surgery on itself in the way that the Northern countries have done in the past. The German plan is based on the fallacy that after you have strangled the patient and destroyed his political system, he will be able to easily re-enter the debt markets at low yields. Markets just don't work that way. These countries will be basket cases for years after the Troika is through with them.

    There is only one way left to rescue the eurozone, and that is reflation, strong nominal GDP growth, and "fiscal monetization". Only the ECB can deliver these goods. This will require the formation of a majority on the governing council to outvote the Germans and their Northern allies. Draghi is now irrelevant, having shown that he cannot bring the Germans around to his point of view. He represents no one.

    Now the South must begin the process of (1) forming a pro-inflation bloc; and (2) wooing countries on the fence to turn their backs on Germany and vote with the bloc. Looking at the make-up of the governing council, it appears to me that a majority could be gathered for the anti-German position, as few countries stand to benefit from the failed German plan.

    Once it is clear that the Northern bloc is going to lose, the Northern countries will have the opportunity to accept the outcome or exit the eurozone. I don't think that any of them will exit (other than Finland), but if they do it will simplify things. The man in the middle is, of course, Hollande. If he is smart, he will join Club Med and escape from Merkel's embrace. He has certainly sent signals along those lines.

    The alternative to ECB rescue is chaos, default, and disorderly breakup.

    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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