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Monday, July 30, 2012

What’s Up Doc?

According to Wikipedia, Kabuki is a classical Japanese dance-drama known for the stylization of its plot and for the elaborate make-up worn by the key performers. This definition also seems to fit the drama in an unknown number of acts currently being acted out on the European stage by some of the continent’s leading central bank players perfectly.

It all started last Thursday when, as surely everyone but my blind and deaf uncle must now know, Mario Draghi made what is widely though to have been an important speech. We will do whatever it takes, as long as it is in the mandate, he is reported as saying. And since stopping anything which could be life-threatening to the Euro dead in its tracks forms part of the bank's mandate under any conceivable interpretation, the ECB now have the widest possible brief within which to circumscribe its actions. The only limitation is that it should be enough, just enough, and no more. As Mario Draghi said, “believe me, it will be enough”.

But then on Friday the Bundesbank dark clouds started to loom on the horizon as the Bundesbank appeared to wade into the fray, making a statement which on first reading  seems to have been intended to say “now just hold on a minute there!” As the Irish Independent put it in a headline “The Bundesbank Pushes Against ECB’s Draghi Attempt To Save The Eurozone".

Yikes! That sounds dangerous. Someone wants to save the Euro, and with it the entire planet, and someone else wants to stop him. Assuming we are not in James Bond territory here, how can that be?

Well, that’s why I say "seem", since digging into the situation a bit, I found it very hard to identify an original source for the statements that were being attributed to that most venerable of German institutions. Certainly there was no trace of anything on the central bank website. If this was a real counter offensive, you would at least expect to see some evidence for it hanging from the bank battelements.

Well, as Ludwig Wittgenstein used to say, when you seem to hit bedrock, and even if the blade is a bit bent, don’t let your spade be turned. Just keep on digging. So I did.

What I found was a Reuters correspondent who claimed to have been told by a bank spokesman that "The Bundesbank regards central bank purchases of sovereign debt as monetary financing of governments, from which the ECB is prohibited by European law”. "The mechanism of bond purchases is problematic”, the spokesman apparently said, “because it sets the wrong incentives." On the other hand the possibility of the EFSF bailout buying government bonds was viewed as "as less problematic".

But then I moved on to Dow Jones News Wires, where I got the weird feeling their journalist had had exactly the same conversation. "Germany’s central bank remains opposed to further government bond purchases by the European Central Bank, but isn’t against using the euro-zone’s temporary rescue fund doing so to drive down soaring sovereign borrowing costs”, a Bundesbank spokesman was said to have told their reporter. Odd, I though that two separate journalists had rung up the bank independently only to have had exactly the same conversation.

In order to try and clarify matters – remember markets next week have to decide what the next chapter in the Euro Debt Crisis is going to be, so it isn’t simply pedantic to want to get this one right - I did what every well trained economist does in cases of an emergency - I went back to the original story that caught my eye in the Financial Times, where to my horror I was unable to find any mention of any conversation - imaginary or real - with a bank spokesman. The FT simply informed the world that "The Bundesbank says....." an assertion that was followed by a wording not that different to the ones to be found in Reuters and Dow Jones Newswires. Then I went to the Daily Telegraph, and found they followed the FT in simply asserting that "the Bundesbank says bla bla bla....."

But where does it say it, and who is saying it? If it is a statement of bank policy why is it not on the website, and if it is the personal opinion of say Jens Weidmann or another top official why is this not made plain?

Why does this matter? Well, maybe this IS being pedantic, but I don’t think we should start accepting that the Bundesbank (or anyone else) thinks something or other simply because the FT says they do, much as I love the paper and its charming corps of staff. Even if we are told “an anonymous source from the Bundesbank who under no circumstances wanted to be identified publically” said x, this can help us evaluate the significance of x. If we are told nothing, then frankly I for one don’t know where to start.

This is a moment when what is needed is absolute clarity about how the Euro Area is going to make the institutional changes that are so badly needed to save the common currency, and this is just what we aren't getting. And I am not the only one who was having diddiculty understanding just what the Bundesbank "intervention" was about. As Martin Essex put it in the WSJ blog:"Did Draghi Not Check With the Bundesbank? "
Could it really be that before European Central Bank president Mario Draghi raised hopes of determined ECB action to lower Spanish and Italian bond yields he failed to check with the Bundesbank? Or do they simply agree to disagree? It wasn’t Mr Draghi’s pledge in a speech on Thursday to do “whatever it takes” that was important. That’s been said before. It was his comment that high Spanish and Italian borrowing costs “hamper the functioning of the monetary policy transmission channel” and therefore come within the ECB’s mandate that boosted the markets, leading to predictions that the ECB will reactivate its Securities Markets Program of bond buying next week.
Thankfully, Bloomberg finally came to my rescue. They owned up to what had actually happened:
"A spokesman for the Frankfurt-based central bank said in a statement read over the phone earlier today that there haven’t been any changes in its position on bond purchases”.
So there we have it, a case of sex (or rather policymaking) over the phone. What journalists were presenting us with was an official Bundesbank statement. In that sense the FT were right, even if they didn't explain why they were right.

Having understood that (which was the hard part) I then spent the rest of the weekend wondering what it might mean. Could the ECB and the Bundesbank really regard it as desireable at this delicate moment to have such a public disagreement? Noting the impact Mario Draghi's statement was having on market confidence, would they really have wanted to undermine his authority. Or was there something more subtle going on?

Looking through the evidence I have come to the conclusion that it was a case of the latter. But it was a close call, and there's no ruling out the possibility that tomorrow we will be given new, additional information which forces me to change my mind.

My reading of the Bundesbank statement (crickey, this is almost becoming theological, or better put "Kremlinological", isn't it?) is that it constitutes a  delineation of what can, and what can't happen next. In this sense it could even be read as being helpful to Mario Draghi. One solution which is actively being anticipated by the markets - giving a banking licence to the ESM - is described as "prohibited" the Reuters quotes, and is thus ruled out.
"A banking licence for the bailout fund would factually mean state financing via the printing press and would be a fatal route, which therefore is prohibited by the EU treaty," a Bundesbank spokesman said, narrowing the ECB's policy options.
Buying bonds in the secondary market, on the other hand, although not actively welcomed by the Bundesbank is simply termed "problematic" and "not the most sensible way" while using the EFSF to buy in the primary markets is very straightforwardly "unproblematic". Now, since the Bundesbank understands very well that Mr Draghi needs to do something, this looks very much like a road map to me - a dose of probematic, but not prohibited, SMP in secondary markets and backing full use of EFSF firepower (such as it is)  in the primary ones.

Adding to the scenification we have a visit by Mario Draghi to Frankfurt this morning, in an attempt to "convince" Bundesbank representatives of the need for action on the part of the central bank. Kabuki theatre in its purest form.

Which brings us to that Le Monde story that was going the rounds last Friday. The newspaper, again citing unnamed - although not evidently Bundesbank - sources, said the ECB was willing to take part in a combined action, but on condition that governments agreed to tap the bailout funds, the European Financial Stability Facility and the European Stability Mechanism.

So here's the key - the countries involved (Spain and Italy) have to request help, and this means conditionality. It wouldn't be a full bailout, the countries wouldn't be taken completely out of the market (commercial banks in Spain and Italy would still be able to go on earning "carry" to help them recapitalise), and the IMF (at this point) wouldn't be involved, but there would be strings attached, and this is important not only for the Bundesbank, but for the entire ECB governing council.

So there we have it. Now it's over to you Mariano. You have to ask for help. And just in case you aren't in any hurry, there are always those kindly market participant types just waiting round outside the gate to act as herdsmen, and cajole you into the corral. But in this case the blows which will rein down upon your financial system will be all too real, and not the stylised replica of them to be found in that Japanese dance drama.

This post first appeared on my Roubini Global Economonitor Blog "Don't Shoot The Messenger".

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