Notes From Underground: Draghi, ECB Declare War on Germany

The deed has been done .The ECB, under the guidance of President Draghi and the Eurocrats in Brussels, have set out to punish the Bavarian Burghers by drastically reducing the interest rates on their saving accounts. Why do I say “declare war on German savers?” Up until the recently, Mario Draghi’s jawboning has been successful in calming the fears of sovereign insolvency. But now real money is going to be spent in pursuing some benefit from a robust QE program.

The original Outright Monetary Transaction policy was based on “promises” to prevent the insolvency of any European nation and the destruction of the EURO currency. It was effective as the sovereign bond yields of all the EU states compressed. It was the rise in yield of TWO-YEAR NOTES that sparked the crisis during summer 2012, with Italian, Irish, Spanish, Portuguese yields all rising to levels above 6 percent.

Today, the yields on those same two-year Notes are:

Italy 0.31%
Portugal 0.24%
Spain 0.23%
Ireland nil

Thus the funding crisis for the European peripheral debtors has passed. During the throws of the crisis Germany was able to exert its economic power and demand that the large debtors invoke severe austerity programs to put their fiscal houses in order. There is no harmonized fiscal structure in the EU so it was only the threat of German failure to backstop the entire project that pressured Brussels to push for policies of budget cuts and tax increases. The superimposed austerity measures have resulted in high unemployment levels for all the nations. As the head of the ECB, Mario Draghi was fearful of German intransigence about bailing out over-indebted nations with massive amounts of liquidity.

The ECB did much talking but little acting. In fact, the ECB was shrinking as previous lending schemes were being repaid. The impact of fiscal austerity, a shrinking balance sheet and falling commodity prices led to an increased threat of deflation across the EU.

As the Fed ended its quantitative easing, Draghi realized that the ECB could move to begin a major program of bond purchases. The French and Italian governments were pushing for a lower euro currency in an effort to stimulate exports. With the U.S. ending its stimulus and the rate differential between BUND and U.S. Treasuries widening it seemed to be a good time to initiate a large-scale asset buying program to help accelerate the depreciation of the euro. The only problem with any QE program is that debtors get bailed out while savers are repressed.

This is not fantasy or speculation on my part but fact, as written in a weekend Ambrose Evans-Pritchard piece, “Mark Carney Warns of Liquidity Storm As Global Currency System Turns Upside Down.” Pritchard quotes the Bank of England Governor: “Mr. Carney defended quantitative eaing against those who argue that it leads to asset bubbles and leads to rising inequality without doing much to boos the real economy. ‘ALL MONETARY POLICY HAS DISTRIBUTIONAL CONSEQUENCES. WE LOWER INTEREST RATES AND IT BENEFITS DEBTORS AT THE EXPENSE OF PEOPLE WHO’VE SAVED MONEY, AND I CAN ASSURE YOU I HEAR FROM SAVERS AND I UNDERSTAND THAT.'” Carney goes further in maintaining that the moral imperative of fighting unemployment is greater then the interest paid to savers.

This is the argument that the FED has used as both Bernanke and Yellen have told American savers that they have benefited from QE in many ways: lower mortgages, increased jobs for their friends, relatives and neighbors and overall a healthier and more robust U.S. The difference in Europe compared to Japan and the United States is that German savers did not vote for the authorities who put in place the policy makers who run the ECB. The end result is FINANCIAL REPRESSION WITHOUT REPRESENTATION.

The fallout from the ECB’s program will not be immediately realized but its potential damage has resulted in Chancellor Merkel being very upset with ECB President Draghi. The FINANCIAL REPRESSION OF GERMANY’S SAVERS WILL PROVIDE ELECTORAL POWER TO THE ALREADY GROWING INFLUENCE OF THE AfD (Alternative for Deutschland).

In Thursday’s post about the outcome of the ECB decision and its nebulous effect upon the 23.7% Spanish unemployment rate, I cited the past work of Professor Carmen Reinhart. A very astute blog reader e-mailed a new research paper by Carmen Reinhart and M.Belen Sbranica released on January 21 by the IMF. It is a working paper and is not the official views of that “august” institution. The paper, titled, “The Liquidation of Government Debt,” discusses how public debt is often reduced through the use of FINANCIAL REPRESSION,”… A TAX ON BONDHOLDERS AND SAVERS VIA NEGATIVE OR BELOW MARKET REAL INTEREST RATES.”

This is not a new area for Professor Reinhart. It builds upon her previous work in understanding the ways in which governments liquidate their accumulated debt caused by wars and social welfare commitments. The power of negative real yields and inflation has the power to destroy the creditors. The use of QE is a move to cap interest rates for debtors and it will not do anything to aid the highly indebted peripheral nations. Combine capped interest rates with higher levels on inflation and you have a sorcerer’s guide to debt repudiation through the alchemy of financial repression.

The ECB’s QE will act to cap the interest rate costs of the debt-plagued peripheries but as I caution: Who will pay the price for the success of that policy? Real estate and equity owners will receive the rewards but pensioners and other savers will bear the cost resulting in even greater disparities of wealth (even George Soros raised that issue at Davos).

The Reinhart/Sbranica paper is packed with analysis of financial repression but one item in particular will be relevant for readers of Notes From Underground as we continually assess the impact of the ECB’s January 22 decision: “No doubt, a critical factor explaining the high incidence of negative real interest rates in the wake of the crisis is the aggressively expansive stance of monetary policy [and more broadly, official central bank intervention] in many advanced and emerging economies during this period. This raises the broad question of to what extent current interest rates reflect market conditions versus the stance of official large players in financial markets. A large role for non-market forces in interest rate determination is a key feature of financial repression.”

This is a critical point in understanding why global bond markets have been rendered irrelevant through the policies of the central banking authorities. Party on Gundlach! It is not the present state of inflation that supports the price of GOLD but the feared outcomes of central bank policies.

***Why The Greek Vote Is Irrelevant: As I write it appears that Alex Tsipras’s Syriza party may have enough electoral strength to govern alone. Many will make this important and the euro will probably sell off tonight if the rumor becomes fact, but all this will do is give Greece greater leverage in negotiating for some type of debt relief with Brussels and the IMF. The success of the ECB’s effort to push yields lower for Italy, Spain, Ireland, Portugal will be undermined by a Greek default or exit from the EU. The costs of a bow to Greek negotiations will be minimal compared to the possible increase in interest rates on other potential high risk debtors.

It is possible that Brussels throws the Greeks out in an effort to placate Chancellor Merkel and reduce German ire over the QE program, but I fail to believe the cost would be worth it. German wealth is now the honey pot for a heavily indebted Europe. Again, the economic table has been set and the ECB is trying to be a good central bank and buy time for governments to enact genuine growth policies.

The Greek debt in deference to buying time will be a tribute to extend and pretend. Greek interest rates on bonds held by the IMF and the European authorities will be lowered and the payment period extended. There will be no default and Alex Tsipras will have a political victory. Going forward, Europe will be about political outcomes for the economic die has been cast.

***One last note. In the Weekend Financial Times, John Authers has a splendid piece, “Draghi’s Pledge Gives Credible Hope to Beating Deflation.” In the article Authers asks the most relevant question about what outcomes the ECB is hoping to achieve with QE. Of course, the ECB’s view is that deflation is the target of its policy and its efforts to flood the EU financial system with liquidity will spur productivity, borrowing and overall economic activity. The rise in economic growth will promote inflation and hence provide relief for public and private debtors.

But even more: “European bond yields are already on the floor. The ECB has already made more targeted efforts to prod banks into lending to smaller companies, a critical point of weakness in Europe. The aim must be to weaken the Euro.And in this ,so far,it has succeeded.” This is a wonderful point and should cause embarrassment to IMF Director Lagarde, who gave her blessings to the ECB’S QE program. The G7 and G20 have railed against government policies that seek to depreciate their currency in an effort to stimulate domestic economic growth.

Call it what you want, but the outcome of aggressive QE programs is a depreciated currency. The problem for the periphery nations in Europe is that the Germans also are the recipient of a devalued currency making that export juggernaut an even greater threat to the global system. The current account surplus and trade surplus will grow in response to a weakened euro. If the German economy doesn’t increase domestic spending the outcome for the entire QE program will be minimal. Again, the focus now becomes on the politics of the European situation.

22 Responses to “Notes From Underground: Draghi, ECB Declare War on Germany”

  1. Mark T Says:

    It’s all about Podemos now.

  2. Yra Says:

    Mark T–that is a very good point and makes the case for reaching a compromise with the Greeks so as not to fire up the rising fringe parties in the rest of Europe.

  3. ShockedToFindGambling Says:

    Yra- The problem with the lowering of rates to absurd levels is that it destabilizes the financial system. Naturally conservative savers have there incomes drastically cut and are pushed into high risk investments, that they don’t really want.

    When the markets turn down, the cushion that conservative savers usually provide to a sinking economy will be minimized, and the recession may snowball.

    Interest rates are a zero sum game. Every dollar saved by borrowers is lost by investors.

    Encouraging borrowing, speculation, and leverage precisely what caused the 2008 crisis.

    The spread between the markets and the economy has increased drastically, and should accelerate the downturn when it comes.

    IMO, the ECB has copied QE because the are intellectually bankrupt.

    They should be able to invent their own boondoggles.

  4. asherz Says:

    I’m not sure that the Greek vote is so irrelevent. Tsipras’ joining with the Independent Greeks Party in a comfortable majority position will interpret the voters wish to throw off austerity and embrace repudiation of debts. Iceland tried this and succeeded. This little Greek pebble in the pond will have ripple effects for the 24% unemployed in Spain, rippling to Portugal and italy.
    The Germans will scream Genug!
    The tumbling Euro’s effect on the Caterpillars and 3M’s will be considerable. The meager yields besides hurting savers is causing tremendous pressures on insurance companies required yields .
    What I’m trying to say is that ripple effects result in unintended consequesnces that are unforeseen by the 21st century monetary alchemists who think that printing presses have replaced base metals that they are convering into the New Gold, now defined as QE.

  5. Yra Says:

    Asherz–the effect on the large U.S. multinationals is not a result of the Greeks—my only point was that the Euro being sold off last night was not because of the fallout from the Syriza victory for the EU was not going to bail on the Greeks because it would be a poor cost-benefit decision with rates where they are—other peripheral debt would result in a risk premium being added to their borrowing costs and that would far exceed the minimal cost of compromising with Tsipras

  6. arthur Says:

    So, Germany, Not Greece, Should Exit the Euro?

  7. yra Says:

    Arthur–we have been returning to that point for at least four years

  8. arthur Says:


  9. deeque Says:

    Hi Sir, pardon my laziness. tried to look for the article/interview on/by gundlach regarding this sentence you said, “This is a critical point in understanding why global bond markets have been rendered irrelevant through the policies of the central banking authorities. Party on Gundlach!”

    you remember the title or some key words of the article? would love to read it. thanks!


  10. ShockedToFindGambling Says:

    Yra- I do not believe the Euro will survive another serious economic downturn.

    France, Italy, Ireland, Portugal and others will be the new Greeks seeking gifts.

    The Europeans need to come up with a big idea that has a realistic chance of helping the real economy.

    “Right now it’s only a notion, but I think I can get the money to make it into a concept, and later turn it into an idea.” – Woody Allen

  11. yra Says:

    deeque–i was making a tongue in cheek reference to Gundlach’s bullishness of the long bonds–the party on reference to the paper by Carmen Reinhart who notes that the central banks have broken the bond markets and will keep buying to keep pushing rates lower—there is not paper with a reference to Gundlach just a comment about how I respect him

  12. yra Says:

    Shocked–as Woody Allen said about central banking –90% is just showing up

  13. ShockedToFindGambling Says:

    Another Woody quote that applies to Central Bankers—-

    “Confidence is what you have before you understand the problem.”

  14. Chicken Says:

    Well, BMW has resorted to playing a soundtrack over the car stereo speakers to make their new puffer 4 cylinder paint shaker residing under the hood sound like a Ferrari. Proof anything’s possible by ignoring reality, in make-believe land.

    Oh, and E85 fuel blend is currently priced 30% less than E10, further proof.

  15. Daniel Says:

    “Financial Repression” makes the balance channel effect sound worse than it is. Surely there is a cost in narrowing the viable investment set for savers and encouraging them to take uncomfortable risks, but with respect to distributional effects this may be a socially beneficial policy.

    If monetizing the debt burden constitutes a transfer payment from the old to the young and reduces inequality while funding riskier positive NPV projects, QE may genuinely be creating value. Alternatively, we might see greater inequality and creation of value (or even destruction of value) as higher returns accrue to savers ex post.

    Time will tell, but it’s not obvious to me that savers shouldn’t be the ones to carry the burden. There is a scenario where savers make more, the indebted are free to reallocate their labor, and QE is wealth-enhancing. Likewise there is another where banks don’t allow debtors to refinance, savers are punished, and business doesn’t expand. Perhaps the silver lining to that uncertainty is that there is a genuine risk premium to risky assets as long as people disagree.

  16. arthur Says:

    Putin Smiles? via The Economist

    “For the Kremlin, which sees the disintegration of the euro zone and the weakening of the European Union as among its main strategic interests, the Greek election results were a gift. Vladimir Putin was quick to congratulate Alexis Tsipras on his victory, and Russian state television gleefully reported that Syriza’s landslide means the end of the EU’s hold over Greece, which “brought the country nothing but unemployment and misery”.

  17. Yra Says:

    Arthur–i think there is great validity in the Economist piece–now if Germany exits as some suggest ought to happen will we get the Molotov-Ribbentrop agreement–renamed Schroeder-Lavrov deal with Chancellor Merkel as the witness to the signing—-that is of course a poor joke–I think

  18. Yra Says:

    Daniel–the point is certainly well taken and the analysis is sound.But when the Fed undertook that role there was a sense that it was a decision by an appointed body responsive to the elected legislature so even if the voices of dissent were silenced they at least had voting power–hence the electoral victory of the so-called tea party in 2010—in Europe the ECB seems to make sovereign decision and even the European Court of Justice gave virtual court blanche to the ECB by acknowledging that monetary policy was complicated and thus the word from the ECB on high was paramount—that is financial repression without representation

  19. Daniel Says:

    Yes good point. The lack of representation in Europe is concerning and reflective of the problem of a lack of fiscal/political unity in the EZ.

  20. deeque Says:

    Hi Sir, if I could just take up a little bit of your time… you mind elaborating more on:

    “This is a critical point in understanding why global bond markets have been rendered irrelevant through the policies of the central banking authorities.”

    do you mean central banking activities have no bearing across the curve or just the longer tenors, >10y ?


  21. Yra Says:

    deeque–No bond market yields have been rendered irrelevant to reality because of the financial repression wrought by the central banks—-German bunds yielding 40 basis points with a fairly stron Germany economy.U.S. GDP in the third quarter of 5% and 30 year bond yields at 2.3%—sorry the bonds are just broken as a barometer of economic activity

  22. Financial Repression Authority Says:


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