ECB Unlikely to Print Money, Financial System to be Nationalized?

The European Central Bank (ECB) is highly unlikely to implement a money printing campaign to bail out various euro zone nations because of a myriad of legal issues preventing such from occurring, according to John P. Hussman, Ph.D.

In his latest Weekly Market Comment, entitled “Why the ECB Won’t (and Shouldn’t) Just Print”, the founder of The Hussman Funds wrote an extensive argument examining the legal hurdles necessary to allow the ECB to begin printing money.  His conclusion was as follows:

There are three basic difficulties with this idea. The first is that ECB buying might help to address immediate liquidity issues of distressed European countries, but it would not address long-term solvency issues, and would in fact make them worse. The second is that the ECB, under existing European treaties, has no such authority, and the prohibitions against it are very explicit. Changing that would be far more difficult than many market participants seem to believe, because it would require an explicit and unanimous change in the EU Treaties that AAA rated countries such as Germany and Finland vehemently oppose. The third difficulty is that even if the ECB was to buy the debt of distressed European countries with printed money, the inflationary effects would likely be far more swift than anything we’ve seen in the United States. This would not “save” the euro, but would simply destroy it by other means.

Additional highlights from Hussman’s analysis are presented below (bold emphasis added by GoldAlert):

Even more notably, the Greek 1-year yield hit 240% last week, with Greek debt of every maturity trading below 37% of face value, and below 28% of face value on maturities of 5 years or more. Even if you were to cut the interest and principal payments on the 5-year bond to half their stated value, the current price of the 5-year implies a yield-to-maturity of nearly 18%. This suggests a credibility problem for the widely assumed 50% writedown figure – not that any Greek debt exchange has actually even been implemented yet. We wonder where this debt is currently valued on the balance sheets of European banks. Given the nearly 40-to-1 leverage common among European banks, it appears likely that much of the European financial system will be nationalized before this is all over.

The bottom line is this, the call for massive ECB purchases of distressed European sovereign debt is not simply a call for a liquidity-providing intervention, but is an attempt to address a solvency issue. Liquidity issues can often be addressed through temporary increases in the stock of money, but to address solvency issues, you have to print permanent money.

There are strong legal restrictions among the EU nations against solvency operations by the ECB, and even if one believes that this is inevitable, the chance of the ECB deciding to abandon EU Treaties on its own is zero, in my view. The main thing to look for, if the ECB is to expand its purchases of distressed European debt, would be a solid effort to impose centralized control on the fiscal policies of the individual European member states. This will be a painstaking process, subject to unanimous approval by EU member states. But I strongly doubt that we will see significant ECB intervention without a formal revision of EU treaties that trades greater ECB flexibility in return for more centralized fiscal control.

Meanwhile, it is helpful to remember that the average maturity of European government debt is only about 7 years. If attempts at centralized fiscal control fail in Europe, I suspect that the best way to address the problems of peripheral European countries (which have structural, not temporary fiscal issues) will be for these countries to extricate themselves from the euro as their existing bonds mature, by issuing new debt that is convertible into their own currencies (which would require a higher yield for the conversion privilege, and would lower but not eliminate the default premium). If these countries solve their problems, no conversion would be necessary. Otherwise, they would eventually proceed with a combination of restructuring, fiscal reform, and devaluation to restore their individual economic competitiveness.

Hussman’s piece can be read in its entirety here:

http://www.hussmanfunds.com/wmc/wmc111121.htm