by Nomi Prins
Two months later, on July 8, the IMF highlighted its unease about the ECB’s commitment to increase bond purchases if necessary. Seemingly unconcerned about the artificial nature of its money crafting, it called upon the ECB to make its €500 billion rescue fund fully available—especially to European banks—in stress periods. The IMF was worried about the “too-big-to-fail” bank problem and the willingness of governments to save any bank in trouble.73
It was right to be. Two and a half weeks later, results of the bank stress tests were disclosed.74 Six of the seven banks that failed the tests were the Agricultural Bank of Greece SA and five Spanish savings banks. The seventh bank was a German real estate bank. The biggest banks all passed; they had been fortified by ECB subsidies and conjured money.
Over the next few months, the euro staged a recovery. The successful performance of European banks in the stress tests reduced the fear of sovereign debt defaults.75 In addition, the euro was lifted on positive negotiations regarding Greece’s bailout and moderate growth rates in the Eurozone. In comparison, a US unemployment rate stuck at 9.5 percent didn’t reflect well on the dollar.
On August 7, 2010, the ECB bought Italian and Spanish bonds on the secondary market for the first time. That kick-started their bond markets, showing speculators they could ride the ECB’s plays. But such purchases of indebted countries’ government securities, which the ECB portrayed as an endeavor to monetize national debt in the Eurozone, were prohibited by the European Monetary Union founding treaties.76
The ECB was creating money to finance countries’ public debt. Critics worried it would increase inflation. But the real item that the ECB had to sell the public—or at least public markets—was confidence. If it could get speculators and investors to buy in to its robust plans, it could spur outsiders to purchase the bonds of struggling countries. The monetary battle was as much about perception and psyche as reality.
Across the Atlantic, a cadre of central banking policymakers gathered in August 2010 at Jackson Hole. There, Bernanke proclaimed no intention of slowing down on easing: “The committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary.”
Trichet concurred. But he wanted to ensure that governments and central banks could safely transition from very high debt levels “incurred in response to the global financial crisis… without compromising economic growth.” For Trichet, the “primary macroeconomic challenge for the next 10 years is to ensure that they do not turn into another ‘lost decade.’”77 The hawk was back.
An August 2010 report from the OECD noted: “Banks tend to be heavily exposed to the sovereign debt of their own country. The exposure of Greek banks to Greek sovereign debt represents 226 percent of their Tier 1 capital. In Italy, Hungary, Spain, Portugal, and Ireland these numbers are 157 percent, 133 percent, 113 percent, 69 percent and 26 percent, respectively.” It went on to say, “The EU wide loss from the haircut is around €26.4bn. The contribution of the 5 countries where most of the market focus has been (Greece, Portugal, Ireland, Italy and Spain) is only €14.4bn.”78
That fall, on November 3, the Fed announced its second round of QE measures.79 With high unemployment, dull economic activity, and low inflation, the Fed offered to “purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.”80 As a result, the dollar fell against its peers and the euro jumped to a nine-month high.81
The next day, at a press conference in Frankfurt, Trichet was asked if he would continue to affirm the United States was pursuing a strong-dollar policy, even though extra QE should have weakened it by keeping rates low. He answered, “I have no indication that would change my trust in the fact that the Federal Reserve Chairman and the Secretary of the Treasury, not to mention the President of the United States, are not playing the strategy or tactics of a weak dollar.”82
He added, “I was also impressed by a recent speech of my colleague and friend, Chairman Ben Bernanke.… The world’s two largest central banks in the advanced economies could hardly be more closely aligned with regard to the inflation rates they aim to establish in their respective economies over the medium term.”83 The two men were like-minded magicians waving the same wand. Coordination was all part of the act and required an honor code to keep it going.
On December 16, following more financial strife—including a €22.5 billion bailout for Ireland and a €26 billion bailout to Portugal as part of a larger package—the European Council set up a permanent bailout fund called the European Stability Mechanism (ESM) to be managed by the European Commission. It was worth about €500 billion, augmenting the ECB programs.84
In the age of central bank excess, money shifted from one crisis to another. Leadership never publicly offered a true diagnosis of the problem or a cure. Prescriptions often leave a patient better in the short term but in desperate need for sustainable treatment for the future.
The ECB, for its part, stood determined to intervene, interject, and craft monetary policy. However, it was like fighting monetary fires with gasoline—especially when political forces were at play. The central bank’s actions were not designed to solve deep-rooted problems unearthed by the global financial crisis and the mega private banks at its epicenter.
By December 2010, three million people in Spain were unemployed, making Spain Europe’s greatest job destroyer.85 The Spanish youth unemployment rate, which was 24.5 percent in 2008, hit 41.50 percent in 2010. In France and Italy, one-quarter of the youth were unemployed.86 The ECB’s single mandate is to achieve price stability. Using that as the caveat for its monetary policy provided cover for the big banks but left millions of people unemployed.
CHANGING OF THE ECB GUARD
On March 3, 2011, at a press conference in Frankfurt, Trichet announced that the ECB would likely raise interest rates in April. His decision was based on the need to keep the inflation rate, which had touched 2.4 percent in February, just above 2 percent.87 As a result, the euro rose to $1.3976, its strongest level since November 8, 2010, resurrecting discussions about the psychologically important $1.40 level.
A shadow dogged the ECB’s decision, cast over countries with the greatest sovereign debt risk, including Ireland, Portugal, and Greece. A rise in rates and a consequent stronger currency would increase the cost of their debts. Germany, however, wanted higher rates because the German banking system competed for deposits with them.
Trichet had to deny his moves signaled the start of rate hikes. The market didn’t want to have to pay for liquidity. This time, Mother Nature intervened. On March 11, 2011, the Pacific coast of Tōhoku off the coast of Japan was ravaged by a magnitude 9.0–9.1 undersea megathrust earthquake. The impact was devastating. It jolted the markets.
In response to the subsequent run on the yen, on March 18, the G7 leaders embarked on a round of joint intervention in the foreign exchange markets. The United States, United Kingdom, Canada, and ECB joined Japan “in concerted intervention in exchange markets.”88
The collaboration of this group could have simply been a new-normal reaction to currency or market seizures in an emergency, but it was more than that. It was one of a series of interventions the G7 financial leaders believed they could make because they knew they could manufacture all the money that was needed. A sort of natural opportunity had presented itself to some of the most unnatural institutions.
Trichet lifted interest rates from 1 percent to 1.25 percent, on April 7, 2011, even as Europe considered a bailout for Portugal, the latest European country to be mired in a debt crisis. He characterized the move as “in the interests of all members and partners of the single [European] market and single currency.” He believed that it would boost economic confidence in Europe. In contrast, the Fed and the Bank of England remained in easy-money mode.89
The southern countries were most hurt by the rising cost of servicing debt. When asked about that impact on peripheral economies,
Trichet generalized that the ECB was “responsible for ensuring price stability for 331 million people” and that “the hike is unwelcome for peripheral countries, but arguably the core member states were in need of this move already some time ago.”90 He was executing a continent-wide balancing act. The general ECB doctrine was one-size-fits-all—up and down.
Yet, when questioned about possible German bias in the ECB’s decision, Trichet became indignant. Comparing the euro area to the United States, as he often did, he said, “I wonder how Ben Bernanke would respond if he was asked whether he did this or that because of California or because of another big state? Germany is a large economy, the largest economy in the constellation of economies that we have in the euro area.… We had an episode of a return to competitiveness, of hard work, and now we see the result of this hard work. It is good for Germany and good for the euro area as a whole.”91
He wasn’t the only conjurer who defied the Fed’s easing directive. When asked about the companion Chinese rate hike, Trichet commented on his relationship with the People’s Bank of China and its governor, Zhou Xiaochuan. “I personally have a very close relationship with Governor Zhou, and we meet very often.… as I have said in the past, central banks do not take the same decisions, as they are not in the same situation. But what really characterizes all central bankers is that they have a unity of purpose… solidly anchoring inflation expectations.”92 Central bankers used inflation as a crutch to either lower or raise rates. At that moment, Trichet and Governor Zhou were united in combating price increases in their own domains.
The Fed marched on while mega-banks remained the walking wounded in need of resuscitation. Thomas Hoenig, Kansas City Fed president, one of the most outspoken Fed officials regarding the need to enforce better behavior in the US banking system, came upon a sensible trade. He believed that big banks such as Bank of America and Citigroup should have their activity restricted by the US government because they were effectively wards of the government anyway. A critic of the Fed’s policy to rescue the banks, he said they were not prepared for the next financial crisis.93 They had paid billions of dollars in fines, and would pay billions more, but remained too big to fail. American banks would send shockwaves to Europe.
By mid-April 2011, the dollar had dropped to its lowest level against the euro in fifteen months. Even with the Eurozone sovereign debt crisis looming, the Fukushima disaster in Japan, and the ballooning political crisis in the Middle East, the dollar had lost its safe-haven shine. Suddenly, the magic of conjured money was suspect.94 Central banks from Europe, Asia, and Latin America sensed trouble in the notion of cheap money’s omnipotence.
Could more cracks in the greenback come? The answer was yes. A month later, the World Bank released a report on the international monetary system and role of the dollar. It expected the US dollar to lose its dominance by 2025, with the euro and the renminbi establishing a “multi-currency” monetary system of three currencies.95
The World Bank also believed “a larger role for the renminbi would help resolve the disparity between China’s great economic strength on the global stage and its heavy reliance on foreign currencies.”96 It wasn’t the only post–World War II supranational organization to throw support to China—the IMF was on that same track.
At a press conference in Frankfurt on June 9, 2011, Trichet remained in tightening mode. He called for another likely rate rise in July due to rising commodity and energy prices, saying, “We remain strongly determined to secure a firm anchoring of inflation expectations in the euro area. This is a prerequisite for monetary policy to make an ongoing contribution towards supporting growth and job creation in the euro area.”97
Trichet emphasized the three paths of attack Europe had—monetary policy, fiscal policy, and structural reforms. He stepped out of the confines of monetary policymaker to defend political austerity measures that he believed would restore European growth in a “responsible” way.98 This was momentous. By treading beyond his official role as major central banker, concerned only with setting rates, he advocated restricting government programs for citizens.
It was not only Trichet but also the euro elite who demanded austerity in return for bailout money. In practice, that meant crippling the population, making the likelihood of Greece repaying a bailout or its debt slim. After the June 2011 Euro Area Summit in Brussels, the heads of state of the euro area and EU institutions welcomed “the measures undertaken by the Greek government… as well as the new package of measures including privatization recently adopted by the Greek parliament. These are unprecedented, but necessary, efforts to bring the Greek economy back on a sustainable growth path.”99 It didn’t matter to them what they gave up in the process.
The ECB was split on whether to buy Italian and Spanish debt to help lower its cost.100 It had bought Irish and Portuguese bonds before, but not Spanish and Italian ones. After Italian prime minister Berlusconi pledged to hasten reforms in return for financial help, his opposition said he was “surrendering sovereignty to the European Central Bank.”101
The IMF was undergoing its own transformation. On July 5, 2011, former French minister Christine Lagarde was elected to become its managing director.102 Two days later, the ECB announced another rate hike of 0.25 percent on its main refinancing operations.103 Trichet considered inflation of 2.7 percent as “clearly” revealing a tendency toward high price levels in the next few months.104 He was seeing the efficacy of his long-held policies.
The IMF overstepped the Italian government by calling on Italy to do more to reduce public debt—one of the highest in the Eurozone—and push spending cuts.105 Yields on ten-year Italian bonds had jumped 200 basis points, from 5 percent to above 7 percent, by November. Italy’s borrowing costs shot to record highs as parliament rushed through radical budget cuts to stave off debt crisis contagion.106
More central bankers overstepped the borders of monetary stewardship. On August 5, 2011, Trichet sent a confidential letter to Zapatero regarding the Spanish public debt market and suggesting reforms.107 According to the Spanish newspaper El País, the letter “makes evident the loss of control of the democratically elected governments of the periphery of the single-currency bloc over their own economic affairs, even those that were not in receipt of full-blown bailouts.”108
The move didn’t come without sharp trepidation. According to the London-based Independent, which called Trichet “the Guardian of the Euro” on August 5, 2011, “As governor of the ECB, Mr. Trichet was also accused of being ‘more German than the Germans’ and being obsessed with inflation rather than growth.”109
The line between the influence of central bank conjurers and governments was increasingly blurred. In response to market hysteria, the ECB finally announced on August 7 that it would purchase Italian bonds in an attempt to reduce the nation’s borrowing costs. This lowered yields to the 5 percent range.
On August 10, the Bank of England promised more stimulus would be provided if needed. The BOJ expressed concern about yen appreciation, and the SNB announced efforts to avoid an overvalued franc. Troubled about global recession, the banks vowed to “take all necessary measures to support financial stability and growth in a spirit of close cooperation and confidence.”110
About a month later, on September 15, the ECB announced it would lend dollars to Eurozone banks that had limited access to dollars. It would coordinate with the Fed and other central banks on various dollar liquidity operations to ensure enough dollars were available through year-end.111 After three years of ZIRP, there weren’t enough dollars in the system to go around. This announcement was a tacit admission that fabricated money was, in essence, causing the evaporation of money.
As previously noted but critical, Christine Lagarde proclaimed the IMF’s emergency bailout fund might not be enough to cover problems in the event of an actual emergency. She confessed, “Our lending capacity of almost $400bn looks comfortable today, but pales in comparison with the potential financing needs of vulnerable countries a
nd crisis bystanders.”112 It was a dire prognosis, pointing to not only the IMF’s but the entire central banking system’s failure to stabilize confidence.
Her warning followed the announcement of a plan to replenish the European Financial Stability Facility bailout fund eightfold from €440 billion to €3 trillion. The German and French Eurozone leaders were in panic mode, fearing a sovereign debt crisis.
Emerging market countries demanded solutions to the Eurozone crisis. Brazil’s finance minister Guido Mantega said that Europeans had a responsibility “to ensure that their actions stop contagion beyond the euro periphery.”113 PBOC governor Zhou Xiaochuan said, “The sovereign debt crisis in the euro area needs to be resolved promptly to stabilize market confidence.”114 The tide turned as China stormed the international stage.
In the United States, inflation wasn’t a concern, but the unemployment rate had barely budged, holding stubbornly at 8.6 percent. Banks hoarded the money the Fed provided them instead of lending at comparable levels to small businesses that could hire people. In September 2011, their cash holdings rose to 14.2 percent of their financial assets, the highest ratio since 1977.115
Also in September, the Italian senate approved a €54 billion (£47 billion; US$74 billion) three-year austerity package. S&P cut Italy’s debt rating to A from A+ anyway, an action influenced by “political considerations.”116 On October 14, Prime Minister Berlusconi barely won a confidence vote over his handling of the economy.117 His victory was short-lived. On November 13, doubts over Italy’s debt burden escalated, and Berlusconi resigned after his government failed to achieve a full majority during a budget vote. Former European Union commissioner and hardliner economist Mario Monti took his place. On December 22, Italy’s senate approved Monti’s $40 billion austerity package.
European leaders reunited in Brussels on October 26, 2011, to discuss the euro and the sovereign debt crisis. German chancellor Angela Merkel warned, “The world is watching” and “if the euro collapses, then Europe collapses.”118 It was the fourteenth summit in twenty-one months. According to Merkel, “Nobody should believe that another half century of peace in Europe is a given—it’s not.” Although German politicians were united in support of an increased European bailout fund, Germany was unwilling to allow the ECB to lend money directly to countries in the Eurozone. The functioning of the Eurozone took a backseat to Germany’s self-interest.
