Excerpt from the Hussman Funds’ Weekly Market Comment (5/17/10):
Last week, the European Central Bank pledged to spend as much as 750 billion euros (about a trillion US dollars) in an attempt to discourage market concerns about European debt, particularly that of Greece, Portugal and Spain. The intended message was to show the markets – particularly bond market “vigilantes” speculating against European debt – that the ECB has deep enough pockets to thwart the mounting pressure on European debt and the euro itself.
ECB President Jean-Claude Trichet has been quick to deny concerns that the move by the ECB will be inflationary, emphasizing that the intervention will be “sterilized” in order to prevent a major increase in the amount of euros outstanding. This is “totally different,” he argued last week, from the massive increase in monetary base that has occurred as the U.S. Federal Reserve has bought up over $1.25 trillion in debt obligations of Fannie Mae and Freddie Mac. A “sterilized intervention” is one where the euros created through the purchase of distressed Euro-area debt will also be absorbed by selling other assets from the ECB’s balance sheet, in order to take those euros back in.
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In the end, as I’ve argued repeatedly over the years, monetary policy is only as good as fiscal policy. A central bank does not have wealth of its own. It is a zero-sum entity that can only enrich those from whom it purchases debt by debasing the relative wealth of people who hold the existing stock of currency. If a government insists on running deficits, engaging in wasteful spending, and dissipating public resources to bail out private bondholders, it has to find somebody willing to buy its debt. If it does not, the central bank buys it, and dilutes the currency by doing so. The situation is particularly insidious when the central bank buys low-quality debt, because there is no taxing authority behind it to provide a basis for confidence in the currency.
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Without a central taxing authority, the goal of a common European currency can only survive if the participating countries obey a rule that strictly controls the deficits of individual countries. Without that, the whole system is compromised. It should not be difficult to recognize that the confidence in any currency is tied to the confidence in the assets which stand behind it, and associated confidence in the restraint of fiscal and monetary authorities. The bureaucrats in both the U.S. and European central banks have chosen to betray that trust. It’s fascinating that they seem genuinely surprised when their generosity with other people’s wealth (and their assurance of greater betrayal) is met with contempt. While I expect that the euro will survive by the coordination of its stronger members, it risks being debased by the unwillingness to accept debt restructuring sooner rather than later.
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