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Once again the so-called technocracy that is the Eurozone looks like a farce – Bill Mitchell – Modern Monetary Theory


So last week, the Bank of Japan remained the last bank standing, the rest in the advanced world have largely lost the plot by thinking that raising interest rates significantly will reduce the global inflationary pressures that are being driven by on-going supply disruptions arising from the pandemic, the noncompetitive behaviour of the OPEC oil cartel and the Russian assault on Ukraine. The most recent central bank to buckle is the ECB, which last week raised interest rates by 50 basis point, apparently to fight inflation. But the ECB did it with a twist. On the one hand, the rate hike was very mainstream and based on the same defective reasoning that engulfs mainstream macroeconomics. But on the other hand, they introduced a new version of their government bond-buying programs, which the mainstream would call ‘money printing’ and inflationary. So, contradiction reigns supreme in the Eurozone and that is because of the dysfunctional monetary architecture that the neoliberals put in place in the 1990s. The only way the common currency can survive is if the ECB continues to fund Member State deficits, even if they play the charade that they are doing something different. Hilarious.

World price watch

Data from the – International Grains Council – shows that global wheat prices are falling sharply since their peak at the end of June 2022.

The following graph shows the movement in the representative US No 2 Hard Red Winter wheat price since June 27, 2022.

A similar trajectory exists for Maize, Soyabeans and Rice in world markets.

I know that one swallow doesn’t make summer, but when I see commodity prices this I know that there is not likely to be a uniform and persistent inflationary period ahead.

What is going on?

The pandemic pushed up wheat prices because of the supply disruption, which was exacerbated by weather issues (bad drought in the US, for example).

Then Russia invades the Ukraine at the end of February, so the already elevated prices rise quickly because there was the fear that the global wheat supply would be significantly reduced (given Russia and Ukraine’s producer status – around 30 per cent of the world export market for wheat).

So consumer prices on food items started inflating because wheat prices (a major input) accelerated.

As the graph shows, there is now a serious reversal in wheat prices underway because North American production levels are up significantly and there appears to be serious desire between Russia and Turkey to free up supply that is currently being held in blockaded Ukrainian ports.

As to maize and soyabeans, their prices are falling because the weather patterns are improving (drought is over).

And, don’t forget, China seems to have abandoned their lockdown and supplies are flowing again.

What does that all mean?

The food inflation pressures are probably abating.

The ECB finds itself … well, remaining effectively compromised

The relevance of the first section on Wheat prices is to disabuse readers of the notion that prices are accelerating across the board and that drastic action is required from our economic policy authorities.

As each central bank rolls over and the collective of them (bar Bank of Japan) appears to be in a race to see who can increase rates the most in the shortest space of time, we should understand that at present there is no entrenched structural inflation in the system.

There have been no significant second round propagating responses from wages to the initial price hikes arising from the sources mentioned in the Introduction.

So if China’s factories get back to work and get goods onto ships anchored around Shanghai soon enough then a lot of price pressures will evaporate.

A good wheat harvest as the impacts of the American drought recedes see the wheat price fall sharply within the space of a few weeks.

On July 21, 2022, the ECB released a – Monetary Policy Statement – to announce and rationalise their decision to increase “three key ECB interest rates by 50 basic points”.

The decision aims to end the period of negative interest rates (nominal rates minus inflation) but I doubt that we have seen the end given the current inflationary trajectory.

In the same breath, they announced the new “Transmission Protection Instrument (TPI)”, which adds to the acronym soup mix that the ECB and the Euro bureaucrats in general love, but really amounts to more funding government deficits in the Eurozone.

That function has come in various guises the SMP, the APP, the PSPP, the PEPP and now the TPI.

It is hilarious when you really understand what is going on.

In their Monetary Policy Statement they rehearsed the usual guff about interest rates and inflation.

1. “support the return of inflation to our medium-term target by strengthening the anchoring of inflation expectations …”

2. “ensuring that demand conditions adjust to deliver our inflation target in the medium term.” – which means reduce overall spending to match the diminished short-term supply disruptions.

Which means force people into income poverty so they stop spending by rendering them jobless.

3. “At our upcoming meetings, further normalisation of interest rates will be appropriate.”

Meanwhile ‘back at the real economy’, the most recent – industrial production data (released July 13, 2022) is showing that output growth has fallen France, Belgium and Germany (among other Eurozone Member States) and Europe’s manufacturing and export powerhouse, Germany, is now running trade deficits and its future looks grim, given its import-dependency on Russian energy and its failure to break away from diesel-based motor vehicles and move into EVs more quickly.

The ECB acknowledged that in its statement:

Economic activity is slowing. Russia’s unjustified aggression towards Ukraine is an ongoing drag on growth … Firms continue to face higher costs and disruptions in their supply chains, although there are tentative signs that some of the supply bottlenecks are easing. Taken together, these factors are significantly clouding the outlook for the second half of 2022 and beyond.

Read that carefully.

They are hiking rates when Europe’s economy is slowing and the inflation is due “disruptions in … supply chains”, which are “easing”.

The rate hikes won’t quicken that easing.

They won’t stop the War.

And they will, if anything accelerate the real output slowdown.

The ECB also acknowledge that supply disruptions are easing because the restrictions are easing.

But like all things to do with the European Union and the Eurozone, they cannot really hide from the dysfunctional monetary architecture.

In anticipation to what last week’s decision might bring, I wrote this blog post last month – Eurozone anti-fragmentation confusion – its really simple – the ECB has to continue to fund deficits or kaput! (June 20, 2022).

So now we know that the ‘anti-fragmentation’ tool is to be the – Transmission Protection Instrument (TPI).

As usual, the ECB dressed it up officially in this way:

The TPI will be an addition to our toolkit and can be activated to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area. The scale of TPI purchases depends on the severity of the risks facing policy transmission. Purchases are not restricted ex ante. By safeguarding the transmission mechanism, the TPI will allow the Governing Council to more effectively deliver on its price stability mandate.

This is the same sort of justification that they came up with way back in May 2010 when they introduced the Securities Market Program (SMP), which saw them embark on the first of their large-scale government bond buying ventures at a time when it was likely Italy and other states would not be able to borrow sufficient to cover their expenses and their pre-existing debt obligations.

The interesting aspect of the TPI is not that it is unlimited but appears to be freed from guidelines operating on the previous bond-buying programs that required the ECB to broadly follow the capital key – that is, buy Member State debt in proportion with their contribution to the capital of the ECB.

Now the ECB is saying it can go for broke whenever.

The purpose, of course, is to maintain control over the bond spreads (against the lowest risk public asset the German bund).

If the ECB didn’t maintain that control, then the private markets would push the spreads up significantly and probably beyond the level that some Member States could afford to borrow and repay.

That means insolvency.

And that was the threat in 2010 and again in 2012 and ever since.

What the ECB is effectively doing by entering secondary bond markets and buying huge volumes of government debt is what any reasonable person would understand to be ‘funding’ government deficits through direct currency creation.

The mainstream call this ‘printing money’ which is a loaded term.

But don’t be fooled by all this talk about ‘smoothing’ “disorderly market dynamics” etc. The ECB is maintaining the power to negate the preferences of the bond investors by controlling government bond yields.

But the purpose is not to control the yields but to ensure that the bond investors who ‘make the market’ in the primary issuing phase of the debt process keep buying government debt (knowing they can offload it to the ECB in the secondary market).

So the ECB is really funding the Member States deficits.

The official statement says:

1. “Subject to fulfilling established criteria, the Eurosystem will be able to make secondary market purchases of securities issued in jurisdictions experiencing a deterioration in financing conditions not warranted by country-specific fundamentals” – the rub is to assess what is warranted or not.

2. The ECB will buy public debt from 1 to 10 years, but also says it can buy private debt (maybe to bailout some big company or bank)!

3. There will be a “cumulative list of criteria to assess” which Member States will be protected this way – but the Member States must “pursue sound and sustainable fiscal and macroeconomic policies.”

4. The Member State must be compliant with:

(a) “with the EU fiscal framework: not being subject to an excessive deficit procedure”.

(b) “absence of severe macroeconomic imbalances”

(c) “fiscal sustainability: in ascertaining that the trajectory of public debt is sustainable”.

(d) “sound and sustainable macroeconomic policies”.

The TPI will augment both the PEPP and the Outright Monetary Transactions (OMT) programs.

Assessment of the ECB Hoopla

The policy announcements last week demonstrate how riven the ECB and the whole European policy machinery is with contradictions and false premises.

First, they continue the charade that they believe in the primacy of private market decision making.

Second, the rationale for the interest rate rises is that inflation is the result of excessive demand relative to the disrupted supply.

That is, entirely mainstream.

But then they know that if all they did was pursue the mainstream interest rate hikes, there would be widespread insolvencies across the southern Member States (first) – Italy would almost certainly go broke and Spain, Greece and Portugal would not be far behind, with France following next.

Cyprus etc would be in the mix too.

So in that respect they have to continue the very non-mainstream policy programs that see it exercising its direct capacity as the currency issuer and funding the Member State deficits.

The mainstream claim that is inflationary.

Contradiction then.

Third, they maintain the charade that they are operating within the rules of the Treaties that govern the conduct of the European Union and the common currency.

But, of course, they are not, because those rules specifically preclude the central bank from funding deficits.

Hence all the word gymnastics and disorderly monetary dynamics to make out that the bond-buying programs are just regular monetary policy moves to ensure they hit their interest rate target.

They know as well as I know that if they didn’t do that the common currency would be dead, and, quickly.

So the ECB is exhibiting its schizoid personality more clearly than ever.

It pretends to be a regular central bank but is in fact, by dint of the dysfunctional monetary architecture, a quasi fiscal authority.

Fourth, with Germany now in real trouble – export surpluses gone, a massive energy crisis imminent, its manufacturing strategy looking seriously defunct and wages growth relative flat – the control that the Bundesbank has had on the ECB Council looks to be waning.

The last thing the Germans wanted was for the PEPP to continue and a new, unrestrained (effectively) program in the guise of the TPI to be announced.

In the last weeks, we have read statements from German commentators claiming the rising bond spreads were good, because it would force some discipline on Italy.

They wanted Italy to suffer more pain than it already is enduring (almost to the point that its social stability is under threat) because, apparently, they were lazy and profligate.

The reason Italy is in a parlous state is really because it surrendered its currency sovereignty.

But the implications of the ECB decision last week was that it was not going to let Italy go to the bond market wolves.

The troubles that Germany now find themselves in – begging Spain etc to use less gas so it can use more, for example, – has clearly diminished its European bullying capacity.

For how long remains to be seen.

Fifth, it will be very hard under the current monetary policy settings (with rates rising) for the European Commission to revoke the special clause that suspended the Stability and Growth Pact and restore the Excessive Deficit Mechanism.

That is, they will find it hard now to start forcing damaging fiscal austerity onto Member States any time soon.

And the ECB will find it hard restricting the TPI to nations that are seemingly operating with the SGP.

That would be illogical.

During the GFC, they used the bond-buying program to keep Member States solvent while the Commission was simultaneously pushing damaging austerity onto nations.

But that mix is not viable now. The bond-buying programs, even though the eligibility criteria for the TPI talk about fiscal obedience, will continue because without it, nations go broke, such is the ridiculous architecture of the euro system.

Finally, the ECB is now the top rank – it rules the roost. It can decide more or less how much each Member State will spend and can pressure the states to modify fiscal policy or face the threat of no TPI participation.

The link between voters and their governments has been increasingly eroded since the common currency was created.

Now the breach is very stark and the so-called ‘democratic deficit’ is obvious.

Who would want to be part of that system?

Conclusion

Once again the so-called technocracy that is the Eurozone looks like a farce.

That is enough for today!

(c) Copyright 2022 William Mitchell. All Rights Reserved.



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