Spain And Italy Are Toast Unless Germany Allows The ECB To Print Trillions Of Euros

The financial chess game in Europe is still being played out, but in the end it is going to boil down to one very fundamental decision.  Is Germany going to allow the ECB to print up trillions of euros and use those euros to buy up the sovereign debt of troubled eurozone members such as Spain and Italy or not? 

Nothing short of this is going to solve the problems in Europe.  You can forget the ESM and the EFSF.  Anyone that thinks they are going to solve the problems in Europe is someone that would also take a water pistol to fight a raging wildfire.  No, the only thing that is going to keep Spain and Italy from collapsing under the weight of a mountain of debt is a financial nuke. 

The ECB needs to have the power to print up trillions of euros and use that money to buy up massive amounts of sovereign debt in order to guarantee that Spain and Italy will be able to borrow lots more money at very low interest rates.  In fact, this is probably what European Central Bank President Mario Draghi has in mind when he says that he is going to "do whatever it takes to preserve the euro". 

However, there is one giant problem.  The ECB is not going to be able to do this unless Germany allows them to.  And after enduring the horror of hyperinflation under the Weimar Republic, Germany is not too keen on introducing trillions upon trillions of new euros into the European economy. 

If Germany allows the ECB to go down this path, Germany will end up experiencing tremendous inflation and the only benefit for Germany will be that the eurozone was kept together.  That doesn't sound like a very good deal for Germany. Read more >>

Eurozone Unemployment Hits Record High

The European Central Bank is widely expected to make an interest-rate cut this week to try to invigorate the eurozone’s ailing economy after unemployment in the region climbed to a record high and a key survey of manufacturing showed the sector to be at its weakest in three years.

Attention is back on the ECB’s role in helping the eurozone emerge from its debt crisis, after last week’s EU summit agreed that the central bank should play a role in common bank supervision. Leaders also backed the view of Mario Draghi, ECB president, that eurozone bailout funds should be offered directly to recapitalize struggling banks.

Few analysts expect the ECB to offer politicians a quid pro quo this week by giving further direct support to banks or governments such as more cheap loans or bond buying. But markets are pricing in the likelihood that the ECB will respond to worsening economic data by cutting its main policy rate to below 1 per cent for the first time – a step that should help peripheral eurozone banks that rely on central bank borrowing. Read more >>

ECB, Commission Working On Greek Exit Plans

The European Commission and the European Central Bank are drawing up plans should Greece abandon the euro, Trade Commissioner Karel De Gucht said in an interview published Friday, the first time a senior official in the European Union executive has acknowledged such preparations.

The ECB and the commission are "working on emergency scenarios in case Greece does not make it," De Gucht said in an interview with the Flemish newspaper De Standaard. Phone calls to and messages left from Dow Jones Newswires to De Gucht's office were not returned.

A commission spokeswoman denied that contingency plans for a Greek exit were under way. An ECB spokesman said in an e-mail the bank doesn't "engage in any speculations about any emergency plans or possible scenarios and therefore do not comment Commissioner De Gucht's statement." The "immutable preference" is for Greece to stay in the currency bloc, he said, echoing comments Wednesday from ECB President Mario Draghi. More...

Road map that brings shadow banking out into the open

Gillian Tett

Entitled The Shadow Banking System, the graphic depicts how money goes round the modern world, particularly (but not exclusively) in the US.

At the top lies a smart section labelled the “Traditional Banking System”, in which a simple flow of boxes explains how investors’ funds are deposited with traditional commercial banks, which then transform this into long and short-term loans, and equity.

So far, so comprehensible. But most of the poster is dominated by two sections called “the “cash” and “synthetic” shadow banking systems, or those “financial intermediaries that conduct maturity, credit and liquid transformation without access to central bank liquidity or public sector credit guarantees”, as the associated NY Fed working paper says. These flows are so extraordinarily complex that hundreds of boxes create a diagram comparable to the circuit board of a high-tech gadget. Even as poster size, it is difficult to decode.

But it should be mandatory reading for bankers, regulators, politicians and investors today. Indeed, they might do well to hang similar posters next to their desks, for at least three reasons. For one thing, this circuit board is a reminder of how clueless most investors, regulators and rating agencies were before 2007 about finance. After all, during the credit boom, there was plenty of research being conducted into the financial world; but I never saw anything remotely comparable to this road map.

That was a striking, terrible omission. The Fed now estimates that in early 2008 shadow banking was $20,000bn in size, dwarfing the $11,000bn traditional banking system. And though this shadow system has now shrunk to a “mere” $16,000bn, this remains bigger than traditional banking, at some $13,000bn. Little wonder, then, that so few people immediately appreciated the significance of the seizing up of shadow banking in 2007.

But secondly, this poster is also a reminder that many things about the modern financial system remain mysterious - even today. On the edges of the circuit board, the NY Fed economists list all the government programmes that have supported the system since 2007 (and, in effect, replaced shadow banks when they suffered runs). This “shadow, shadow bank system” - as it might be called - looks complex and baffling too. And in practical terms, the sheer breadth and complexity of that box makes it hard to know what will happen if - or when - government aid disappears.

Then, there is the current regulatory debate. So far this year, the Financial Stability Board and other international bodies have focused most of their reform attention on issues such as bank capital, and systems of oversight for large, systemically important banks. Next year, though, Mario Draghi, head of the FSB, wants to start discussing the shadow banking world.

Many national regulators are keen to do this too as they recognise the danger of looking at regulation just in terms of institutions. After all, the crisis has shown how risky it is to have $16,000bn worth of maturity transformation without any backstop, or clear rules. This week, for example, Adair Turner, head of the Financial Services Authority, the UK regulator, promised more scrutiny. Earlier this year Paul Tucker, deputy UK central bank governor, suggested that it was time to see which parts of the system were benign - or not. The US government is now considering whether to extend the regulatory umbrella to large, non-bank institutions such as Citadel or GE Capital.

But whether this desire for a debate turns into sensible reform remains unclear. For getting politicians to focus on the issue may not be easy in 2011. There is already considerable regulatory fatigue. There are also other, more urgent distractions, such as the sovereign debt crises. And shadow banking issues rarely seem “sexy” in political terms, unless they involve hedge funds (which pose less systemic threat than, say, the vast $3,000bn-odd money market fund sector.)

So for my money, the best thing the NY Fed could do right now is print thousands of copies of that poster - and dispatch it across the world. I suspect it would be far more persuasive about the need for debate than any number of pious G20 speeches. After all, a key reason why that circuit board became so complex was that bankers were trying to arbitrage the last two sets of Basel rules. If shadow banking continues to be ignored (ie politicians focus just on the traditional banks) there is every chance Basel III will simply produce another complex labyrinth that will go largely ignored. Until the next crisis.