Monday, August 20, 2012

It took Germany's central bank less than a day to knock a reported proposal by the ECB to set interest rates caps on Spanish and Italian bond yields.

Bloomberg reports Bundesbank Widens Euro Rift With Criticism of ECB Bond Plan.
Germany’s Bundesbank stepped up its criticism of the European Central Bank’s plan to embark on potentially “unlimited” government bond purchases, widening a rift over how to tackle the sovereign debt crisis.

“The Bundesbank holds to the opinion that government bond purchases by the Eurosystem are to be seen critically and entail significant stability risks,” the Frankfurt-based central bank said in its monthly report today. The new program “could be unlimited” and decisions about potentially far greater sharing of solvency risks should be taken by governments or parliaments, not by central banks, it said.

The comments suggest Bundesbank President Jens Weidmann won’t support a measure the ECB is rushing to design to help reduce governments’ borrowing costs and win them time to implement fiscal reforms. Spanish and Italian 10-year bond yields slid to the lowest in more than six weeks today after German news magazine Der Spiegel reported the ECB’s new program may set yield caps. In response, the ECB issued a statement saying it’s “misleading to report on decisions which have not yet been taken.”

The ECB issued a statement today saying a bond-yield cap has “not yet been discussed by the ECB’s Governing Council,” and it is “wrong to speculate on the shape of future ECB interventions.” It didn’t deny that ECB officials are considering the idea.

German Finance Minister Wolfgang Schaeuble said on Aug. 18 that the debt crisis mustn’t become a “bottomless pit” for his country. “There are limits,” he said, ruling out another aid program for Greece. At the same time, two German lawmakers said last week that Merkel is considering easing Greece’s bailout terms.

The Bundesbank has resisted ECB intervention during the crisis before. Former President Axel Weber resigned last year after becoming isolated over his opposition to the ECB’s original bond-buying program. Former Bundesbank vice president Juergen Stark also left his position as ECB chief economist in December in protest at the purchases, which were shelved in March this year.

Bundesbank Isolation

“Nobody should try to create the impression that the Bundesbank or its president are isolated,” German ECB Executive Board member Joerg Asmussen told the Frankfurter Rundschau in today’s edition.
Precisely why is it wrong to discuss what fools might do, especially when the fools will not deny that they just might do something amazingly foolish?

Consider what I said yesterday in ECB Considers Interest Rate Caps; Can Such a Scheme Possibly Work? when this story first surfaced ...
Can This Work?

It depends on the definition of "work". In general, if central planners (and it is important to understand that is what we are talking about here) set prices too high there will be unlimited supply.

Likewise, if central planners set prices too low, there will be shortages.

When it comes to interest rates, the ECB must be willing to buy an unlimited number of bonds (up to the total supply of all bonds).

Theory vs. Practice

So yes, the ECB can "in theory" defend a price target on bonds, but only at the risk of owning every bond.

What about an exit mechanism? How will the ECB get rid of all those bonds down the road? To who, at what price?

Will Germany go along with this ridiculous scheme? For how long?

As is always the case, interference in the free market by central planning fools always fails in the long run.
The German central bank clearly agrees with my analysis, but they might be isolated and outvoted.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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