Draghi Net

Word out of Europe is that the ECB will launch a “sterilized” bond buying scheme by purchasing short-term sovereign debt in the secondary market. “Sterilized” means that the ECB would absorb the money set loose in the markets from bond buying. It could accomplish this by borrowing the money back at a yet-to-be-determined interest rate. By going the sterilized route, the ECB could counteract the potential inflationary and currency-devaluating effects of monetary easing. What a minute, isn’t monetary policy supposed to add to the money supply? Isn’t some measure of currency devaluation desirable to boost exports, etc.? You can stop rubbing your eyes, ECB President, Mario Draghi, has not gone mad. He has a different objective than the pro-bailout speculators. The pro-bailout camp desires money printing, some currency devaluation and a continuation of the status quo on the periphery. Mr. Draghi simply wishes to keep the eurozone intact while structural reforms can be gradually implemented. This is clearly a rescue of the eurozone, rather than a growth stimulus program. Germany is exercising influence over the ECB as it has been the Germans who have expressed fears about inflation. Strings are attached to this bond buying. There will be criteria attached to the bond buying scheme. There will likely be memoranda of understanding and fiscal criteria for any country involved in the bond buying program. This includes asking for an official bailout and opening up its economic books. As of now, the only countries which would qualify for such bond buying are Greece, Portugal and Ireland. Spain and Italy have not asked for bailouts. The prospects for Italian and Spanish bond buying tomorrow (following the ECB meeting) are very slim. As such, the markets reacted and corrected back to pre-rumor levels. The days of money throwing are over. Strings will be (and should be) attached, if only because the Germans are the grownups in the room. Even if the ECB would rather broaden the scope of the bond buying program, unlimited bond buying is a difficult proposition. It is difficult because the ECB cannot print money. It has not ability to print euros. The printing of currency has to come via a unanimous agreement by eurozone members. We do not see the Germans agreeing to wanton money printing. Let’s Make a Deal What lies ahead for the eurozone? There are basically three scenarios: 1) The eurozone moves closer to the French/periphery economic model. 2) The eurozone moves closer to the German model. 3) The eurozone fragments. Our view is that, unless there are dramatic culture shifts, scenario number three seems the most likely outcome. Like a Surgeon Investors and speculators looking for a magic cure for Europe are likely to be disappointed. Sometimes the herbal cures don’t work and surgery is necessary. The only question is: Where will the cutting occur? Will it be sovereign governments restructuring their economies or cutting free of the eurozone. Tom subscribe to Bond Squad please got to: http://www.bond-squad.com/subscription.htm Tom Byrne tom@bond-squad.com. www.bond-squad.com www.mksense.blogspot.com 347-927-7823 Twitter: @Bond_Squad