Tuesday, May 11, 2010


The clamor concerning the eroding credibility of the ECB interesting to witness. Divorcing monetary policy from fiscal policy is difficult enough within a sovereign nation (witness the Fed's attempt to navigate through the political labyrinth with varying degrees of success).

But, as usual, expediency is the rule of the day for politicized institutions. This is especially true of the ECB, which has no institutional experience with crisis (and as I have repeatedly said, apparently had no contingency plan in place for severe market stress).

And so the perception of the ECB will be permanently tarnished as it folds. The several governments are already performing their own contingency analysis to be prepared when the Euro fails.

With more and more chatter out of Deutschland, this is a certainty.

May 11 (Bloomberg) -- There is an old saying among central bankers that credibility is earned in years of hard work, but can be lost overnight. On Sunday night, the European Central Bank may have said goodbye to its credibility when it agreed to buy the government bonds of euro nations in trouble.

This casts a dark shadow over the euro area’s 750 billion- euro ($980 billion) stability package, which was dressed to impress, and seems to have worked so far. Markets will probably advance in the near term as short positions need to be covered.

A major casualty of the emergency decisions was the ECB. With its move to prop up the failing bonds of governments in financial distress, it has allowed itself to be transformed into an agent of fiscal policy. The intention to sterilize bond purchases means, in effect, that it taxes euro-area private borrowers to support governments in difficulty. In the long run, this is likely to undermine confidence in the ECB and the euro.

Markets last week gave their thumbs down to the Greek rescue program led by the euro area and the International Monetary Fund, probably for two reasons: fears that Greece can’t implement the program, and that Greece wouldn’t return to solvency even if it did.

Here is what has scared investors (apart from the riots in Athens): Even if the IMF program were fully implemented, the Greek debt ratio is projected to rise to 150 percent of gross domestic product by 2013. Assuming an interest rate of 5 percent, Greece would pay 7.5 percent of its GDP to bondholders. With more than 80 percent of creditors being foreign by then, the country would transfer at least 6 percent of its GDP abroad.

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