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Thursday May 6, 2010 - 16:43:28 GMT
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ECB Sticks to Script…Price Stability, What Crisis (FXA)

I thought the ECB had a little more chutzpah when it comes to saving the EUR, EMU and the world.  If there is one lesson from the 2008 crisis for central bankers it is be bold early.  Dithering is disastrous.  Today Trichet dithered.  Okay the euro is still above its long-run average of around 1.20 so one can say why respond to impetuous markets with radical policy measures like QE?   Keep powder dry until you see the whites of the eyes of the crisis.  Until then Greece is a flesh wound (Pythonesque). 


Okay maybe I was wearing my Fed goggles when I wrote my Alert Wednesday that outlined some likely chess moves from the ECB to calm markets and show the central bank got it…what was primarily a fiscal (political) problem in the EZ is now primarily a monetary problem.  But the only crisis I heard Trichet refer to today was the one in 2008, not the one burning in plain view on his Blackberry real time. 


But that view assumed that the ECB is a flexible institution in the face of a crisis.  To be fair to some extent the ECB proved in the 2008 financial crisis that it could be flexible (okay forget about its summer rate hike in 2008) by introducing LTRO’s at fixed rates and unlimited amounts of cash.  But the crisis of 2008 was of a banking (debt or credit) nature, not of a sovereign nature.  The ECB is not armed with any authority to respond to fiscal or political crises, especially if the antidote requires policies that potentially compromise its raison d’être…price stability.  QE or debt monetization is incompatible with a single mandate of price stability.   The threshold for the ECB to respond to the current crisis with radical policy measures like buying Club Med debt from the markets is much higher than it is for the Fed (buying MBS to arrest the housing market decline).  In other words the ECB needs to view events as overwhelmingly tipping the scales in the direction of deflation. The Fed often talks about policy measures as insurance against undesirable outcomes (like deflation).  The ECB has no capacity for taking out insurance policies and its response is heavily constrained (subjectivity removed) by inflation, inflation expectations and the money supply.  In other words it could not respond even if it wanted to. Hence today’s inconceivable admission by Trichet that the Governing Council never considered buying government debt (QE).  Okay maybe this was a fib and ECB did put lots on the table for discussion and chose not to reveal it fearing it would dilute its impact if and when deployed down the road. But frankly I am inclined to believe him…unwavering on this point.  


Okay we should acknowledge that the ECB is not thoroughly dogmatic when making important policy decisions…it dropped its collateral conditions on Greek debt (at least one of three major rating agencies rate it investment grade) which was very friendly on the liquidity side ad suggested the ECB sees the linkage between sovereign credit run and a banking system run.  But this was done in the spirit of EZ/EU government’s along with the IMF doing the yeoman’s share of the policy response to Greece.


Yes I as the facts change I change my opinion.  After today it is very clear that

the debt crisis engulfing Greece and fouling the beaches of the Iberian peninsula needs to get much worse before the economic (and political) calculus changes sufficiently to prompt more radical policy steps by the ECB.  Like in Monty Python’s Holy Grail, we can all see what happened to the Black Knight Sir JC Trichet.   Let’s hope Sir JC Trichet has more than his teeth to prevent this crisis from taking down EMU, the EUR, European banking system and the global recovery.


David Gilmore 



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