A Ponzi by any other name

Published in Business Spectator (Melbourne), 9 February 2012

Georgios Chatzimarkakis, a German-Greek member of the European Parliament, just had a splendid idea. In an interview with tabloid newspaper Bild, he suggested a new name for Greece. From now on the country should only be called ‘Hellas’ in every language. The old Greece, famous for corruption and sleaze, badly needed a better image and a new name might help, the politician argued.

Chatzimarkakis certainly knows a thing or two about the importance of names and titles. He recently lost his PhD after severe cases of plagiarism had been detected in his doctoral thesis.

However, what sounds like a stunt from a desperate backbencher with an image problem is not uncommon in Europe. Policies too tainted to sell to a suspicious public are simply given another name. And clearly Longer-Term Refinancing Operation sounds better than ‘Ponzi scheme’, let alone ‘money printing’.

Yet money printing is what the European Central Bank’s interventions in markets have come down to. After the first round of showering banks with nearly €0.5 trillion of cheap cash in December, an even bigger wave of central bank money is expected by the end of February.

While EU politicians are haggling over an extra few billions for Greece and Portugal, the ECB’s interventions make such sums look like small beer. The mainstream expectation for the ECB’s next LTRO tender on February 29 is for about €1 trillion. It could be even more because, in principle, European banks can borrow unlimited amounts of money from the ECB for three years at a minuscule 1 per cent interest.

The complicated workings of the ECB’s policies effectively hide a most dubious scheme. What the central bankers are doing under the guidance of ECB President Mario Draghi is not so much financial alchemy as a sacrilege against monetary stability. To stabilise both banks and governments, the ECB has transformed itself into a vault for toxic papers, a subsidiary of fiscal policy, and quite literally, a cash cow for the financial sector.

There have always been three options to manage the euro crisis, at least temporarily (the fundamental issues are more complicated): Europe could give up the euro; the EU could move towards full fiscal union; or the ECB could monetise public debt. The first two options are politically impossible, and the third is illegal under European treaty law, which forbids the ECB from financing European governments through the printing press.

So the ingenious Draghi, an Italian ex-Goldman Sachs banker, devised a fourth option. Well, actually it is just the third option of debt monetisation in disguise. To make it comply with the letter of the law, if not the spirit, and also to keep Europe’s bankers happy, newly created central bank money is passed through the financial sector before reaching the coffers of national finance ministers. Sadly, the consequences of such monetary activism are just as pernicious as ordinary debt monetisation.

The ECB was meant to be a central bank independent from government, exclusively committed to price stability. Throughout the financial crisis, this independence has taken a battering. By soaking up government debt on the secondary market, against increasingly dubious collateral, the ECB has become a player in the field of fiscal policy. The whole purpose of these exercises had been to massage down yields on government debt.

With its unprecedented LTRO operations, however, the ECB is entering even more dangerous territory. To enable Europe’s banks to benefit from the unlimited cash shower, the ECB has reduced collateral requirements so much that commentators are joking that it is just a matter of time until the ECB will accept toilet paper, presumably even single-ply. This also means that the risks of Europe’s fragile banking system have been more or less dumped on the ECB.

The hazards of this procedure are obvious. At just over €81 billion subscribed capital for the central banks of the eurosystem, their balance sheet total already stands at €2.7 trillion. Following the expected LTRO tender later this month, the figure will exceed €3.5 trillion. Compared to the ECB, the highly leveraged Lehman Brothers was a conservatively managed institution.

The ECB cannot afford any bank failures or government haircuts in the eurozone, in which it would have to participate. Its buffers are way too small to deal with an escalation of the financial crisis.

For the time being, however, the ECB can congratulate itself on calming Europe. Since the first round of LTRO on December 21, the Euro Stoxx 50 index went up 11 per cent, and Italian 10-year-bond yields are down from their peak of 7.3 per cent to a less dramatic 5.7 per cent. The euro crisis? What was all that about?

But beyond the visible short-term effects lurk the prospects of increased trouble. Instead of correcting the continent’s balance of payments problems, the ECB’s intervention has cemented them. It has also reduced the urgency for periphery governments to reform their economies and consolidate public finances. Why should they when they can refinance themselves easily through the banking sector now awash with cash? In this way, two of Europe’s core problems – trade imbalances and public debt – are not being tackled precisely because of the ECB’s provision of cheap credit.

Another complication with the ECB’s LTRO programme is that, so far, nobody has proposed a plausible plan to wean Europe’s banking system off the drug of cheap central bank money. The first injection only led to expectations of an even bigger injection in February. But before that shot could be administered to the sick patient, speculation is building about a more powerful dose later this year.

Draghi’s central bank thwarts any attempts at economic reform by taking yields pressure off periphery governments. It keeps a terminal monetary union on life support without curing its many diseases. It creates vast amounts of money which one day may well create inflation outside asset markets, where it is already underway. And it is an imaginative monetary scheme that keeps on giving as long as the next shot of monetary stimulus is in sight – but not a single day longer.

Once upon a time, we would have called this a Ponzi scheme. But Longer-Term Refinancing Operation sounds so much more respectable. Perhaps Draghi should hire Mr Chatzimarkakis as his spin doctor.

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