European Central Bank Makes EU Summit Irrelevant
by Jason Jenkins, Investment U Research
Tuesday, December 13, 2011
Sometimes I get the feeling that international markets are the naive girl next door who’s dating the EU bad boy. He knows exactly what to say to send her heart a flutter. But in true bad boy form, he’s going to break her heart.
Last Thursday, a bombshell dropped before European officials could even get together. Mario Draghi, President of the European Central Bank (ECB), declared that he could only aid European banks and didn’t have any institutional power to act as a lender of last resort to sovereign states.
The ECB brought to an end almost all hopes that it would put its bond-buying program in overdrive to aid in the Eurozone’s sovereign debt crisis. Uneasy markets had believed in the days leading up to the summit that a grand bargain would be reached to end the turmoil.
What the ECB did do was cut rates to a record low of one percent and offered a graciously long three-year financing to banks while easing regulations and collateral requirements for banks to tap its funds.
Draghi, playing down expectations the bank would boost its bond purchases, was disappointed and surprised that markets were hoping the ECB would ramp up its bond buying ability if Eurozone officials came to some sort of austerity agreement this weekend.
Less Than Expected
The ECB President denied his December 1 remark that “other elements” could follow a push toward fiscal union was a signal the ECB could step up its bond-market intervention, saying he was “kind of surprised” it had been interpreted that way.
Under his interpretation, the European Union treaty prohibits the European Central Bank from “monetary financing” and the bank is constrained by its institutional setup.
The market wanted the ECB to fire a “bazooka.” Instead, it’s getting a six-shooter. The bazooka would have been for the ECB to launch a quantitative easing to offset the obsessive austerity measures the Eurozone could have agreed upon this weekend.
And apparently, this would have saved Europe from the brink. Or would it? Was the market’s response over the last couple of days based on political and economic logic or was it just the current market acting as it has repeatedly over the past few months – overreacting to headlines?
How sound was this plan heading into the weekend?
Ask yourself these two important questions and see what you get:
- Why was there so much optimism in the first place for the ECB saving sovereign states? The bank is very conscious that it’s a European institution and has to abide by EU treaty law, and Article 123 of the Lisbon Treaty prohibits the financing of governments.
- Does the plan submitted by German Chancellor Angela Merkel and French President Nicolas Sarkozy bear any resemblance to Draghi’s ideas of “fiscal compact?” More importantly, can their plan actually win the support of all EMU states? Hungary’s EU Commissioner Laszlo Andor said the plan was a joke and that any fiscal union “needs collective, democratic decision-making.”
The package of measures is a fiscal union in name only. There’s no joint debt issuance, no shared budget and no fiscal transfer. Will it even be enforceable? Sanctions will be imposed by EU ministers, but France and Germany will each have a veto.
Eurozone governments are now left to do the heavy lifting. And they have shown time and time again that the burden is too great. Headline risk and volatility will remain in the short-term market, so keep the faith with those strategies we’ve been preaching over the last several months.
Good Investing,
Jason Jenkins
Article by Investment U
