Monday, 6 August 2012

Doing everything necessary may not be enough for euro

Contrary to the expectations of many analysts and traders, both the Federal Reserve and the European Central Bank took no new action to ease monetary policy last week after their respective monetary policy meetings.

The lack of action from the ECB after its meeting on Thursday was particularly surprising at first after President Mario Draghi had said that he would do everything necessary to preserve the euro. Markets reacted by selling Spanish and Italian bonds.

However, the sell-off was reversed the very next day after Germany signalled that it might agree to the ECB buying government bonds.

Fund manager John Hussman's take on these developments, however, were not as positive. In his latest commentary, he wrote:

With regard to Europe, it’s interesting how the semantics of the phrase “everything necessary” has been used to obscure the differences between Euro-area countries when it comes to monetizing bad debt. The distinction can be seen in a comment last week by German government spokesman Georg Streiter: “The ECB president said that the ECB will do everything necessary to preserve the euro and the government will do everything politically necessary to preserve the euro.” As long as the phrase is shortened to “everything necessary,” everyone is in agreement. The differences are in the subset of actions that constitute “everything.” For the German government, it is everything politically necessary. For Finland, it is everything necessary provided that collateral is pledged for every loan. For the German courts, it is everything legally necessary. While everyone can be unanimous about their commitment to doing “everything necessary,” it’s important to recognize that “everything” means something different to each party.

The divergent stances will prevent what Hussman thinks is actually required to save the euro.

... ECB purchases of distressed sovereign debt would most likely have to be permanent purchases, and would therefore represent a fiscal transfer at the expense of stronger countries that would prefer to use the proceeds of money creation for the benefit of their own citizens… Germany is only willing to mutualize the debts of its neighbors if it can exert centralized authority over their fiscal policies – in Angela Merkel’s words “liability and control belong together.” But while Europe is geographically united, it is culturally and politically diverse, and a surrender of national sovereignty to the required extent is unlikely.

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