ECB Inflexibly Flexible - a Turning Point for the Euro?

By: Axel Merk | Thu, Jun 10, 2010
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Following the European Central Bank's (ECB) press conference following its monthly meeting, President Trichet's main task was to boost credibility. As Trichet makes abundantly clear, the ECB is "inflexibly attached to price stability." To achieve its goal, however, he could have added the ECB needs to be inflexibly flexible. When quizzed on the ECB bond purchase program, a program that may take the ECB down a slippery road of money printing should it not be properly neutralized, Trichet discussed three elements: the purpose, the design and observation of the program.

This sounds simple enough, but raises many questions:

In the coming weeks, over €400 billion in longer term funding that the ECB has provided to the banking system will expire. At its meeting today, the ECB announced that fixed-rate, full allocation tenders will take place July 28, August 25 and September 29 of this year. Think of it as an all-you-can-eat fixed price lunch, the preferred support mechanism the ECB has provided to the markets, a support mechanism that addresses any liquidity issues that may be in the markets. The advantage of the ECB approach relative to the Federal Reserve's is that the ECB facilities run out (or can be periodically renewed), providing a more flexible exit strategy than the Fed's approach, which has loaded its balance sheet up with much longer duration mortgage backed securities (MBS). Indeed, part of the challenges the eurozone is facing may well be a result of the early elimination of some of the programs; the ECB has had to re-open these facilities; in contrast, the Fed has, net, not mopped up any significant liquidity as the MBS program has more than superceded any previous facilities.

Such facilities, however, do not address solvency issues; on this topic, Trichet pointed to the great strides that have been made, particularly in Spain, to address solvency issues amongst regional banks with heavy real estate losses. More broadly speaking, Trichet praised initiatives taken on the fiscal side, including the commitment of finance ministers "on the priority of halting and reversing the increase in the debt ratio and welcomes the commitment to take immediate action to that effect." It shall be noted that such actions have indeed been taken with significant budget cuts not only announced, but already passed by the weaker eurozone governments. Just as important as fiscal consolidation are structural reforms; here, Trichet blatantly says, "wage-bargaining should allow wages to adjust appropriately to the competitiveness and unemployment situation." Cost cutting alone won't make the eurozone more competitive; bold announcements have some from select countries, most notably Germany. The coming months will show what reform measures will be implemented.

As a first test of whether the ECB press conference has increased confidence in the markets, it shall be noted that this is the first time the euro rallied both during and in the hours after the meeting. Is this a turning point for the euro? Possibly; incidentally, as the markets start to embrace Europe's approach to the way it deals with its crisis, other currencies, including the Norwegian krone, Australian and Canadian dollars may benefit more as risk-friendly capital comes back into the markets. Ultimately, we agree with Trichet that convincing fiscal and sound monetary policy is the appropriate path for the eurozone, not debt monetization.



Axel Merk

Author: Axel Merk

Axel Merk
President and CIO of Merk Investments, Manager of the Merk Funds,

Axel Merk

Axel Merk wrote the book on Sustainable Wealth; peek inside or order your copy today.

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered an authority on currencies.

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