Equities ripped, bonds sold off, and the little Aussie bruiser rallied to ~1.04 last night on reports that ECB Draghi said the ECB would do ‘whatever it takes’ to hold the Euro together…
I doubt the ECB has what it takes …
First of all, let’s think about what a central bank does – it buys (and sells) securities and pays for them with high powered money. So its assets are the securities it owns, and its liabilities are the money that it creates.
Sounds like something for nothing – real assets in exchange for ‘created’ money – but it is not. The money it creates is a taxpayer liability, and is booked as a loan from the banking system (who in a closed system are forced to hold the central bank’s liabilities).
If one thinks of the high powered money the central bank creates as a part of total government liabilities (and one ought to) it is immediately clear that all the central bank does is lengthen and shorten the duration of outstanding government liabilities.
When a central bank buys long term government bonds, for example, they exchange short term government liabilities for long term government liabilities.
Do you really think the trouble in Europe is that they are trying to issue too much long term debt?
I do not. I think Europe’s problem is that they cannot afford to repay the debt that is currently outstanding. Shortening the term structure of those liabilities will reduce the duration (and hence risk) held by the private sector – and this may cause the private sector to make other more risky investments … But i doubt it will have an especially large impact.