Redirecting

Monday, May 17, 2010

Quotable: John Hussman


"ECB President Jean-Claude Trichet has been quick to deny concerns that the move by the ECB will be inflationary, emphasizing that the intervention will be "sterilized" in order to prevent a major increase in the amount of euros outstanding. This is "totally different," he argued last week, from the massive increase in monetary base that has occurred as the U.S. Federal Reserve has bought up over $1.25 trillion in debt obligations of Fannie Mae and Freddie Mac. A "sterilized intervention" is one where the euros created through the purchase of distressed Euro-area debt will also be absorbed by selling other assets from the ECB's balance sheet, in order to take those euros back in. 

In order to evaluate the arguments being made, it's helpful to understand the balance sheet of a typical central bank. Whether in the U.S., Europe, or elsewhere, the basic structure is the same. On the asset side, the central bank has government debt that it has purchased over time. A small proportion of total assets might be held in "hard" assets such as gold, but primarily, the assets of each central bank has traditionally represented government debt - mostly of its own nation (or in the case of the ECB, euro-area governments). As a central bank purchases these securities, it creates an equal amount of liabilities, in the form of "monetary base" (currency and bank reserves). 

Notice, for example, that the pieces of paper in your wallet have the words "Federal Reserve Note" inscribed at the top. Currency is a liability of the Federal Reserve, against which it has traditionally held assets such as Treasury securities, and prior to 1971, at least fractional backing in gold."

but this is the part I really liked, emphasis mine:
"In this context, consider the ECB's proposed 750 billion euro line of defense. Essentially the ECB is saying "We stand ready to buy as much as 750 billion euros of distressed Euro-area debt in order to defend the euro." Simultaneously, despite the fact that Euro area countries are running large fiscal deficits, the worst being in Greece, Portugal and Spain, the ECB is saying "However, we intend to sterilize this intervention, which will ultimately require that we sell Euro-area debt into the market in order to absorb the euros we create." The only way that both statements can be true is for the ECB to admit "Therefore, we are fundamentally promising to debase the quality of our balance sheet, by exchanging higher quality Euro-area debt with lower-quality debt of countries that are ultimately likely to default." 

Far from being "totally different" from what the U.S. Federal Reserve has done, the ECB is essentially promising exactly the same thing - to corrupt its balance sheet and debase its currency in order to protect the worst stewards of capital from the consequences of bad lending and poor investment."

-KD

5 comments:

getyourselfconnected said...

"Far from being "totally different" from what the U.S. Federal Reserve has done, the ECB is essentially promising exactly the same thing - to corrupt its balance sheet and debase its currency in order to protect the worst stewards of capital from the consequences of bad lending and poor investment."

Yeah but we have the RESERVE CURRENCY! DYKWTFWA?? We drink your milkshake ECB!

OT,
a friend is having a big cookout the 29th and I am making babyback ribs and moinks for the party. Moinks are meatballs wrapped in bacon and then smoked with a bit of hickory. Nice!

Sneak Attacker said...

I was not aware that the Fed sterilized their purchases of this toxic crap. This would be an important difference - the Fed bought this stuff just by pressing a button and creating the money to do so. The ECB is financing their purchases by selling other assets.

Kid Dynamite said...

yeah - i'm not sure that's what Hussman meant there - he said they were doing the same thing by debasing their balance sheet - not by sterilization. in the Fed's case, the Fed just added crap to the balance sheet.

Ken said...

Selling other assets is only one of the prescribed methods to sterilize these transactions and avoid at all costs the appearance of QE.

The 16.5 billion "term deposits" currently being used to sterilize are eligible as collateral against the ECB's repo facility.

1. Buy bonds and put cash in hands of banks.

2. Mop up liquidity via 7 day term deposits.

3. Allow said deposits to be used as collateral for repo lending.

Wash, rinse, rollover, repeat (and hope Germany does not figure out what is going on anytime soon).

Kid Dynamite said...

more here:

http://ftalphaville.ft.com/blog/2010/05/18/233726/sterilised-and-scandalised/