The numbers involved are small. Yet, the Troika/Cyprus move to renege on deposit insurance and appropriate private funds is set to reverberate beyond the tiny island.
The decision bodes ill for future rescue efforts: 1) it derails popular support for any adjustment plan, 2) it reveals the ECB’s promise to do “whatever it takes “ and engage in unlimited OMTs as an empty bluff, 3) it puts the nail in the coffin of the putative European banking union and 4) it turns the plan to create a well-understood resolution regime and creditor hierarchy on its head.
All these serve to undermine the credibility and hence the efficacy of any future rescue attempt in the Eurozone.
Bill Gross argues that credit is losing its power and suffers from entropy, destined to a fatal supernova end. But pay heed to the power of compound interest and the fact that correlation does not establish causation and it is clear that PIMCO’s analysis is nothing but a fallacy of galactic dimensions. Continue reading →
Recent market perceptions notwithstanding, the Fed is unlikely to end its accommodative stance (incl. QE) anytime soon. However, this does not mean that asset markets will continue to derive undiminished support from such actions forever.
Calls for a Yen sell-off have been an ongoing feature of the economic Kommentariat for the past three years. They have gained renewed vigor as the BoJ engages in yet another round of quantitative easing against a backdrop of a relapse into recession, persistent deflation and a deterioration in Japan’s trade performance.
Yet, a sharp depreciation is unlikely, in particular against the USD. The BoJ lags other central banks significantly in the aggressiveness of its monetary operations, the Fed is likely to be further emboldened by the unavoidability of some degree of ‘fiscal cliff’, Japan’s worsening trade performance is dwarfed by the size of incoming capital flows and risk aversion is set to keep JPY bid.
This is not to say that there are not good reasons for the Yen to weaken in the medium term: demographic change and a declining savings rate represent powerful headwinds in the medium term. So does the potential of more radical steps by the BoJ. But neither are imminent and a sharp move beyond 80 thus remains unlikely for now.
In its new round of quantitative easing, the Fed’s operations are now open-ended, unlike in previous instances. What is more, in what could mark a turning point in its approach to monetary policy, it signaled that its loose stance might persist even once the recovery has started.
This decision appears to reflect an underlying shift in emphasis in the Fed’s dual mandate: less concern about the threat of inflation and more concern about persistently anemic unemployment.
If confirmed, it implies that the market rally is less likely to fizzle out quickly and that gold and risky assets will be supported beyond previous cycle highs. The USD will remain firmly on the backfoot.
The reduction of the ECB’s deposit rate to 0% led to an immediate Eur500 mn drop in deposit holdings but prompted a simultaneous increase in current account holdings, leaving overall bank reserves unchanged.
Yet, focus on these figures is misplaced: bank lending, or M3 in general, is independent of the monetary base, i.e. high reserve holdings are not indicative of “cash hoarding” by banks.
What matters is how often these funds are passed around the financial system before they are redeposited at the ECB. As a result, the level of reserves – which further LTROs would boost – is less important than the ‘velocity’ of these funds.
The ECB has few tools to boost ‘velocity’. Uniformly lower rates, SMP purchases, QE and, most importantly, credit easing would all help though.
A fiscal union in the Eurozone (EZ) – whether in the form of additional financing or debt mutualization – is not only politically unrealistic but also counter-productive in dealing with the issues at hand. Transfers or grants would work, but would need to be open-ended to be credible, which is both unacceptable and unaffordable.
Calls for ‘growth-promoting’ policies reflect the ideals of 40+ years of Keynesian folly. To a large extent, these tried and failed policies are the source of today’s debt mountain in many countries. Even if successful, such policies can only have a marginal near-term impact on debt dynamics.
The only viable and politically acceptable solution is a Sovereign Debt Reduction Mechanism (SDRM) for the eurozone. This has the advantage of offering both stock-and flow adjustments, while not calling for an open-ended commitment like a fiscal union. The flipside is that it requires significant support for the financial sector in order to prevent a systemic collapse.