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ECB Announces Conditional Bond Purchase Scheme

European Central Bank President Mario Draghi wrapped up his major press conference this morning, and the news was pretty much what we heard yesterday. Draghi announced the formation of the OMT, or Outright Monetary Transactions. It’s an unlimited sovereign debt purchase scheme for those countries which submit to giving the ECB a vote on their fiscal policies. Here’s a good rundown.

Conditionality. Strict and effective conditionality is attached to ECB purchases of sovereign debt. What this means is: No country gets to have their bonds purchased unless they submit to outside oversight on fiscal matters. IMF observation will get re-elected. Draghi threatens to terminate actions in non-compliance.

Unlimited purchases of 1 to 3 years.

ECB is no longer senior. ECB expects the same Pari Pasu treatment.

Sterilization: The liquidity created through outright transactions will be sterilized.

Transparency: Purchases to be revealed on a weekly and monthly basis.

I find this basically offensive, but Spain, Italy and the others had to know where a currency union would lead. If they couldn’t print their own money, sooner or later they would have to beg the printer if they got into trouble. And so now we’re seeing the loss of European sovereignty.

The other analogy I would make is between this and the US Federal Reserve’s program of quantitative easing. Substantial research has shown that QE, which in the main involves a mass purchase of securities, has not been sufficient to boost the economy. The ECB isn’t even trying to do that in this case; the bond purchases are just staving off a debt nightmare. But the point is that the wrecked economies won’t get a lifeline out of this. In fact, they’ll likely grow worse as this is approximately the worst time to institute the so-called “labor market reforms” Draghi and the rest will demand. This is just going to be more forced austerity, using the leverage afforded by the monetary policy prominence. And anyone who thinks central bankers should be trusted on fiscal policy is crazy. Why should Mario Draghi, who nobody elected, reshape Europe? What expertise does he even bring to the table for such a purpose?

For example, one assumes that Spain will be forced to adhere to targets set up by the European fiscal compact. But their current trajectory would put their budget deficit more than double the limit, 3% of GDP, for this calendar year. So that would mean an immediate cut of over 3% of GDP, for a country with 24% unemployment. Either that, or Draghi won’t buy the bonds. So Spain looks totally screwed here.

The biggest hope is that the mere intention by the ECB to engage in this policy puts a damper on debt yields to such a degree that they remain sustainable. I don’t think that’s Draghi’s goal. For the sake of the people of Spain, Italy, and the other troubled sovereigns, let’s hope it works out that way.

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David Dayen

David Dayen