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ECB’s unlimited bond purchase plan is a perfect con game

(4/5 | 6 votes)

Antonio España.- 09/08/2012

If you were to emulate the character of Thomas Crown in either of the two versions of the film, the 1999 one, starring Pierce Brosnan and Rene Russo, or the 1968 one, with Steve McQueen and Faye Dunaway, and commit the perfect heist, scientifically planned and leaving no trace, you would only have to engage in politics in a monetarily sovereign country. Because there has not been a cat burglar, professional grifter or card sharp who has deceived the people and robbed them of their savings on a scale comparable to the con perpetrated by the monetary policies of governments of all colours and democratic conditions throughout history.

While not an ideal monetary system, thanks to the euro, states that adopted it renounced the possibility of manipulating its national currency and thus, the ability to pull off in solitary the perfect heist, robbing its own citizens to finance partisan goals, imposing the least overt and less democratic tax that can be levied, that is, inflation. Not surprisingly Ayn Rand referred to it as the paradigm of the perfect crime.

Since European nations went off the gold standard and before the creation of the euro in 1999, most governments and central banks of Europe responded to economic crisis in the same way: by printing money and flooding the financial and economic system with liquidity, with the consequent depreciation of the national currency. Just to avoid undertaking reforms that are as unpopular as essential to reduce public spending and liberalize the economy.

However, Austrian School economists like Ludwig von Mises, Friedrich von Hayek or, today, Jesus Huerta de Soto, have taught us that monetary systems that leave money creation at the mercy of the whims of politicians and central bankers, hinder and distort consumption and investment flows, preventing the efficient allocation of resources and generating international financial instability, currency wars, competitive devaluations, artificial credit expansion and inflation.

A better alternative, more solid and stable, and that would end boom and bust cycles, has been proposed by Huerta de Soto. This is supported on three basic reforms: restoration of the bank reserve ratio of 100 percent, abolition of central banks and return to the gold standard. However, it does not seem as if we can see those reforms in place any time soon, so until these reforms can be put into practice, at least we should approach as much as possible the ideal monetary system, avoiding falling again in what Hayek called monetary nationalism.

In the present circumstances, and thanks to the German stubbornness in sticking to a sound money policy, the euro is somewhat boosting budgetary rigor, requiring reforms to improve competitiveness and, at least, slowing down the abuses of the welfare state and political demagogy in spite of being fiat money issued by a central bank and allowing fractional reserve banking within Europe. It is this sense in which we should defend the common currency.

If you don’t agree, just think of former Spanish Prime Minister José Luis Rodríguez Zapatero and current Prime Minister Mariano Rajoy, both interventionists (though one at the left while the other at the right) who have taken measures against their own social democrat principles which would have been deemed as politically impossible before this crisis. Although still insufficient, as evidenced by the evolution of the risk premium of Spanish bonds, and some of them even counterproductive, as the raise in income tax and value-added tax, we must admit that up to now the euro has deprived them of the alibi to commit the perfect heist.

But the European Central Bank's decision on Thursday of undertaking so-called Outright Monetary Transactions (OMT) in secondary markets for sovereign bonds in the Eurozone, that is, unlimited purchase of public debt, is a step in the opposite direction. No matter how blunt ECB President Mario Draghi’s remarks on conditionality could be, the truth is that the he will monetize debt, and that implies, creating money out of thin air. A process which we know, or should know, is inflationary and redistributive. As printing is usually quicker than implementing reforms, new money will be injected into the system well before any spending cut can be really effective.

No matter that what the ECB intends is to fully sterilize this monetization to avoid inflation, as it is physically impossible to do it with no limits. Sooner or later, the central bank won’t be able to keep sterilization at pace with bond purchases, as it happened with the former Securities Markets Program (SMP) started in 2010. “Unlimited” and “fully sterilized” are two concepts that cannot be together in the same sentence.

And, finally, no matter that the Governing Council threatens member states' governments with immediate suspension of the OMTs in case countries do not live up to the conditions eventually set out in the Memorandums of Understanding (MoUs). If the ECB did that, the risk premium would skyrocket again and all of a sudden the central bank balance sheet would end up with a pretty amount of sovereign bonds selling at important discounts in the secondary market. All the efforts would have been fruitless, while ECB accounts would look much worse.

So, you might wonder, why then the market has reacted so well to the announcement? As a matter of fact, Spanish risk premium is near 410 points and all the main stock exchanges are positive at the moment of writing this. Well, this is how scams work, first the confidence is gained and then the fraud is committed. Besides, in any good con game, the mark does not realize he has been taken, at least not until the con men are long gone. And, as we have seen, the OMT programme seems to be a very good, almost perfect, con game.

(4/5 | 6 votes)