Nobody's Perfect Fesselspiele in der Euro-Zone
Mittwoch urteilt das Bundesverfassungsgericht über den ESM-Rettungsschirm. Die Euro-Krise ist schwer zu erklären, zumal auf Englisch: Ist OMT eine Achtziger-Jahre-Band? Was haben Bonds mit Bondage zu tun? Unser Lieblingsbrite Ian McMaster hilft - and now let's switch to English.
Seniority, fragmentation, bond spread, naked shorting, OMT, ESM. No, no, this isn't the latest instalment in the Fifty Shades series, the dreadfully written but awfully successful novels about BDSM. That's bondage & discipline, dominance & submission, and sadism & masochism, in case you wanted to learn those words in English.
Let me make clear from the start that I don't believe that there is a euro crisis at all. The most I'm prepared to concede is that there is a "slight problem" in the euro zone. But then the British are famous for their understatement.
One of the most recent twists in the saga was the introduction on 6 September of yet another abbreviation, as if we didn't have enough already. This latest one is "OMT". At first, I thought that when Mario Draghi, the president of the European Central Bank (ECB), introduced his new policy he was talking about one of my favourite pop groups from the 1980s, OMD, or Orchestral Manoeuvres in the Dark. He wasn't, of course, although "BOMD" wouldn't be a bad description of recent euro zone policy: Badly Orchestrated Manoeuvres in the Dark.
OMG - is it OMT or OMD?
This time, however, the ECB got it just right. It finally took out the "big bazooka" that many experts had been demanding in order to frighten financial speculators who have been betting on the euro's collapse. One form of such betting over recent years, now banned by some countries, has been the selling by investors of sovereign (government) bonds that they didn't own and hadn't borrowed, a process known as "naked shorting" or "naked short selling".
Draghi's big bazooka was the OMTs or "Outright Monetary Transactions". Now, my Oxford Dictionary of English says that "outright" means "directly or openly" or "wholly and completely" or "immediately and instantly". I suspect that not even Draghi knows exactly what he meant by this term.
Whatever. OMTs is the name given to the threatened "unlimited" purchases by the ECB of the government bonds of struggling euro zone countries. That basically means Spain and Italy. Greece is currently shut off completely from the financial markets while it suffers what many Greeks see as German-inspired fiscal sadism.
The aim of the ECB's controversial decision to purchase Spanish and Italian bonds is to reduce the interest rates that these countries have to pay on their new debts. The purchases will take place only after Spain and Italy explicitly ask for help under the euro zone bailout schemes (see below), and also accept the punishment of "conditionality", by implementing painful economic reforms. Spain has already indicated that it won't accept spending cuts or pension cuts.
The ECB argues that such bond buying, which is opposed by the Bundesbank, is within its powers because the euro zone's "monetary transmission mechanism" isn't working properly and is suffering from "fragmentation" and "convertibility risk". It also says it will carry out "sterilization" of the effects of the bond purchases. Still awake? In case you are, let's look at those terms in more detail:
- Monetary transmission mechanism. This is the process by which interest cuts by central banks, such as the ECB, lead to lower interest rates charged by banks to companies and individuals, and therefore cause more lending and borrowing. This mechanism hasn't been working properly in recent years.
- Fragmentation. This refers to idea that investors increasingly see the euro zone as lots of separate financial markets, rather than an economic and monetary union. One reflection of this fragmentation is the wide discrepancy between the high interest rates demanded by investors for Spanish and Italian bonds and the low (and sometimes even negative) interest rates accepted for holding bonds of "safe haven" countries such as Germany or Austria. This discrepancy is also known as "bond spread".
- Convertibility risk. This refers to the idea that part of the high rates demanded for Spanish or Italian bonds is a risk premium to compensate investors for the danger that these countries might leave the euro and convert to using their own currencies again. By making clear statements that the euro is "irreversible" and that it will do "whatever it takes" to defend the euro, the ECB hopes to remove the justification for this risk premium.
- Sterilization. When a central bank purchases bonds in the financial markets, it increases the money supply. To offset that - and so minimize the risk of future inflation - the central bank can sell other bonds to take money out of the markets again. This offsetting process is known as "sterilization".
When announcing the OMTs, the ECB also signalled another policy change. It said that it would not require "seniority" on any new bonds it purchased, as it had previously done in the case of Greece. Seniority means preferential treatment in the case of a default by the government issuing the bonds. Imposing ECB seniority in the case of Spanish or Italian bonds would probably have scared off private investors, who would have worried that they would be at the end of the queue in the event of a default.
This Wednesday we will see another important step in the battle to rescue the euro, the decision by the German Constitutional Court of the euro zone's planned new, permanent bailout scheme, the European Stability Mechanism (ESM). This is the successor to the more limited bailout fund, the EFSF or European Financial Stability Facility - now, try saying that quickly ten times, even before drinking a few German beers.
Imagine a boxing ring with four corners
The more I think about it, the less I believe that it is a coincidence that the ECB's latest bazooka, the OMT, really does sound like OMD. After all, Orchestral Manoeuvres in the Dark's first really successful album was called Architecture and Morality and this sums up perfectly the fight at the heart of euro zone policy.
Imagine a boxing ring with four corners. In one corner we have what I call the "financial moralists". These are people who passionately believe that economic policy should be based on punishment for past sins. In practice, this means punishing the Greeks, Spaniards, Irish, etc. The best I can say for this view is that it is almost total nonsense. Economics is not a morality play; it is about doing the right things for the future, which admittedly includes minimizing the risk of future bad behaviour or what economists call "moral hazard".
In another corner are what I call the "financial architects", a more boring bunch who focus on the fine details of, for example, the institutional arrangements for euro zone banking. These include such sleep-inducing topics as deciding what percentage of their "risk-weighted" assets (don't ask!) banks should hold as capital. (OK, I'll try to explain: "risk-weighted" basically means that the more risky a bank's assets are, the more capital it should hold. If this kind of masochistic detail really does excite you, do a search for "Basel III".) Another favourite subject of the financial architects is the tedious but extremely important subject of the regulation and supervision of euro zone banks, one of the steps towards a much-needed "banking union", which eventually will include a common euro zone deposit guarantee scheme.
So who is in the other two corners of our boxing ring? Well, in one corner are the pragmatists, such as Mario Draghi, who have ignored Bundesbank financial dogma and taken the risk of unconventional monetary policy measures to save the euro. Bravo!
And in the fourth corner are the rest of us, the taxpayers. And we're the ones who the governments will approach if everything goes wrong - to collect money to bail out the banks again. By the way, there's another expression in English for collecting money - "to have a whip round". Which was more or less where we started.
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