THE IRRELEVANCE OF PUBLIC BUDGET RULES
You are kindly required to concentrate on the irrelevant
This weekend papers in the EU are chock full of highly placed figures calling for suspension of EU budget rules, but don't be fooled: it never was material to the situation, and neither it is now.
I open the papers, and there is a recurring theme: EU elites want a more extended period of budget rules suspension. European Commissioner Gentiloni first, President Macron , and also German figures, like Co-founder of the G-20 Eichel, are keeping up the pressure with a view to keeping the German High Court from taking an axe to a “World without end” where unchecked deficit allows a political class to spend freely on their goals with no regard to a functioning market economy.
However, as much as we can delude ourselves, those budget rules (deficits under 3% and a goal to go back to 60% debt/GDP over twenty years) were NEVER intended to accommodate a market economy at all, far from it. They were a “payment for services rendered”.
Those services were extended courtesy of the ECB: the monetization of debt [implicit] in the QE and other measures had at least on the surface be counterbalanced by a kind of brake, since absent a thriving financial market where savers would have mauled stupid or wayward policies via spread widening, something else should be put in place to give at least a semblance of efficiency, or at least of soberness. Since it's not politics that keeps populists out of power, but it is government bond spreads, some tool had to be put in the arsenal to do that job.
What was not contemplated at the time was that such an arrangement was stable, in the same sense described in Lewis Carrol1: "Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!"
Where is the stability? Well, it's perfectly simple.
Increased credit spreads erode the spending ability of the debtor (government) and improves the spending ability of the creditor (thrifty savers). That, by itself, might improve productivity because by definition governments either act in or create monopolies for themselves and their protegèes. It doesn't take public ownership to create what is effectively a single blob controlled single handedly by government forces, as any students of banks and utilities should know.
So, given the absence of at least a “Best Before “ tag, that policy inevitably would assume the present form, COVID or not: bond purchase programs by central banks not only can't be reversed, they cannot even be STOPPED, and given the diminishing returns, there is a tendency to increase them. That can be stopped, even reversed for short periods (QT tantrum, anyone?), but eventually reasserts itself even more forcefully.
Taking “speculators” away caused governments to lose any incentive to keep some powders dry in case of problems.... because of a quirky interpretation which was in my opinion dead wrong, but alas, it's not material any more as well. Too late to set things right.
That interpretation is this, and it's material to the coming decision in the German High Court. The German “Grundgesetz”, and more fundamentally the German psyche, is dead set against unfettered money printing. You know, Weimar.
It's not “debt monetization” on a promise, done originally by practically all central bankers, that not only the process WAS reversible, but that it WILL be reversed by normalizing the size of Central Bank balance sheet. In short, that Central Banks would either sell or let expire enough of their bond portfolios to shrink their assets to where they were originally.
Yet, the monetary authorities the world over grudgingly admit that the key difference between them and Rudy Haverstein is NOT what they are doing now (well, maybe the scale), far from it: the difference is that not only it should be reversible, but that it WILL be reversed.
Pity that no one, especially the proponents, put any schedule in the plan. And absent that, I find it increasingly difficult to scrape up the courage to take pen and pencil and see what would that mean in terms of the equivalent of government bond sales if, for example, that would be scheduled to start in 2030 and last seven years, in order to go back to 2014 levels.
Just so you know: It would be like placing the ENTIRE debt of Italy all over again, on an accelerated schedule. Given that ECB policy has been very effective at reducing rates, anyone has any reasons to think that it would work as well in reverse?
Let's do a quick back of the envelope approximation of the numbers potentially involved, always under the proviso that this is neither investment advice nor forecast: Italian ten year government rate was at over 4% when the Central Bank intervention really came in earnest and drove the rate to 0.6%2 True, we hadn't had COVID, but neither was the debt load in terms of percentage of GDP as high3. On 2.600 Billion of public debt4, the rough numbers5 go like this:
Given that the average
maturity is roughly 7 years, the table above would be an “end
state”, provided that the ECB by doing what they told they would,
caused rates to reach the relevant yield level on day one and to stay
there on average throughout the period, not so far fetched given that
markets are anticipatory mechanism. And even at 2.5%, the about 50
bn. EUR additional price tag would be 1.5 times the yearly Recovery
Fund "Danegeld" to Italy, which is in any case mostly additional debt.
In fact, while in the EU it seems that the coordination between the EU political authority and the ECB is quite extensive, that is less prevalent in the Anglosphere, Yellen notwithstanding. The FED has already made some tentative steps to counteract Inflation pressures in the system, and also the other members have put out feelers, see preoccupations abut the impact of lax policy on Real Estate prices in NZ and AUS for example.
But the sad truth remains, that the men in Karlsruhe have an heavy burden on their backs, since there is a sense of “last train stop”: If they will fix their gaze on the weak point of the issue they are examining6, which the “joint and several” characteristic of the joint bond issuing program, and remember that one of the reasons they accepted the legal challenge was that due to its protracted nature it could conceivably be said that it's not “an emergency program” at all, then a debate might be sparked about fixing a date and schedule for winding down QE. And if it's within a generation, say “start of normalization in 2035, 10 year selling period”, we might be in for interesting times.
6https://www.politico.eu/article/bernd-lucke-economist-germany-recovery-fund-europe-professor-nein/
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