(Ed.: This article originally appeared in the September 4 "Weekly Insight" column of EWI's intensive Currency and Interest Rates Specialty Services.)
European Central Bank President Jean-Claude Trichet has proven throughout this financial crisis that he is his own man when it comes to navigating the euro-land banking system through the deflation and debt deleveraging storm. He has proven to be an excellent communicator, consensus builder, and a maverick among the world’s central bankers. To his credit, and much to the benefit of the 16-nation euro region, his policy positions of eschewing massive fiscal stimulus and rejecting excessive quantitative easing (QE) have proven that Trichet is no slave to fashion.
Many have pointed out that among the world’s prominent central bankers, he saw the looming financial meltdown and voiced his concerns while many others touted the new and wonderful world of financial engineering. Trichet was most concerned by the complexity and opaqueness of debt products that were beginning to dominate finance.
On October 12, 2005, the Federal Reserve Chairman Alan Greenspan gave a speech to the National Italian American Foundation, and the following quotes reveal the en vogue thinking of the day: “The new instruments of risk dispersal have enabled the largest and most sophisticated banks, in their credit-granting role, to divest themselves of much credit risk by passing it to institutions with far less leverage…These increasingly complex financial instruments have contributed to the development of a far more flexible, efficient, and hence resilient financial system than the one that existed just a quarter-century ago.”
The following month, in Basel, Switzerland, Trichet was quoted, “Perhaps there is an underestimation of risks by financial markets at the present juncture.” Clearly, Trichet was unwilling to follow the siren call of the newly-engineered ‘Money for Nothing’ that clogged the balance sheets of banks, hedge funds and insurance companies on both sides of the Atlantic.
As the financial meltdown began in 2007 and the Fed fell over itself in a rush to slash interest rates, Trichet and the ECB bucked the easy monetary policy trend and held rates firm through July 2008. In the U.S soon came TARP, TALF, an alphabet soup of bailouts, special lending facilities and asset purchases, and then a massive fiscal stimulus package. By the summer of 2009 the Fed had committed more than 12% of U.S. GDP to asset purchases under the guise of QE -- all a desperate attempt to keep banks liquid and asset values artificially high. The UK soon followed, also committing more than 12% of annual GDP to its own QE program. Jean-Claude Trichet, on the other hand, was unwilling to provide funds for even 1% of aggregate GDP for the covered bond purchase program.
The European Union contains 27 member states, only 16 of which belong to the euro area, and the ECB cannot force any member state to undertake fiscal policy. They also have disparate needs: Spain, Greece, Iceland and much of the eastern bloc need capital infusions, while Germany, France and the UK think that such burdens are unfairly weighted. Hence, we see the International Monetary Fund playing the role of the ECB where direct cash infusion is required. In the end, it is the lack of monetary enforcement that will likely save Europe from overspending and committing hundreds of billions of euros in a vain attempt to prop up deflating asset values.
In the U.S., it would take a generation of above-average growth (combined with confiscatory taxation) to eliminate the projected deficits, given the recent actions of our central bankers and legislators. Japan tried stimulus in the nineties (to no avail), and the U.S. and the UK are playing the same game now.
Jean-Claude Trichet, ever cautious, was recently quoted, “What is very important for a central bank is not to succumb to fashion… What we try to do is to take decisions, including when needed, bold decision that are designed…to preserve…monetary stability. We think we have reasonably struck the balance between those two considerations.” (Bloomberg) Given Europe's lack of debt overload, I would agree. Trichet is no slave to fashion.
Bill Fox is EWI's Senior Bonds Analyst and editor of EWI's intensive Interest Rates Specialty Service. He has been involved in the markets since graduating in 1988 from Vanderbilt University. He joined EWI in 1994; most of his subscribers are professional bond traders.