Has the ECB gone mad?

Founder and Publisher of the Switzer Report
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The challenge for investors running their own DIY super fund is: do I go to cash until this Europe-driven stock market drama ends, or do I punt that a rescue will happen in the nick of time, like in a Hollywood blockbuster?

So, who could be the caped crusading superhero? There is only one — the European Central Bank — but its hands, for the moment, seemed tied.

The New York Times writer, Jack Ewing, put it neatly saying the ECB has a “fire hose” to put out the flames engulfing the eurozone’s debt-ridden countries – that is, they can print money.

Is the heat rising in Europe? Yep. Treasury bills in Italy are up 3% in a month! That’s a solid measure of the fear that investors have when it comes to European Union government debt — trust is going up the chimney.

Okay, so we have a fire and the fire brigade is standing by and doing virtually nothing; how come?

Both CommSec’s Craig James and AMP’s Shane Oliver believe the ECB has to use their hose to take the heat out of the situation.

This is because investors don’t trust European government debt and that’s why bond yields, or interest rates, are rising. James says Europe’s governments need to find investors that are willing to buy their bonds – “a white knight if you like, like the European Central Bank.”

If this happened then the yields on the bonds are kept low and then this takes pressure off the governments to meet their interest bills as well as other bills.

So why is the ECB holding back and are they likely to change their mind? Such an action would send the stock market hurtling upwards.

First, it’s not the central bank’s job to lend to governments to sort out their budgetary problems. However, this is an excuse because the US Federal Reserve did it; they could see that GFC fears had choked up the banking system and ensuring the monetary system works is the job of a central bank.

Second, the ECB fears excessive money printing will lead to inflation. That’s true, but it doesn’t have to be excessive as the US has demonstrated.

Third, Germany doesn’t want the ECB to play superhero because it doesn’t want the consequences, such as inflation and higher taxes, in the future to bail out irresponsible members of the EU. Well, this is a spurious argument because Germany’s debt-to-GDP ratio is 82.4% while Spain’s is 68.1% and France’s is 84.7%.

Sure, Greece’s debt -to-GDP is at 157.7% and Italy at 120.3%, which is way too high, but the eurozone’s acceptable level is supposed to be 60%, which means the Germans are overrating their responsibility. By the way, the ECB has been doing a bit of bond buying, but they would only call this finetuning for the sake of price and interest rate impacts.

The apologists for the ECB point to its charter, but if the situation developing on global stock markets is not arrested soon, a GFC Mk II will ensue and then deflation will become the concern and that’s when the money will be printed.

Jack Ewing got it right when he pointed to the background of the new ECB boss, Mario Draghi, who once worked for Goldman Sachs. I suspect the Germans will be pressured to relent and the ECB will eventually turn up with the biggest hose in history.

If not, there will be a lot of investors drowning their sorrows in some pretty stiff drinks. So, is the ECB mad? No; misguided, but it will eventually come to its senses.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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