Author : John E. Charalambakis
Date : September 12, 2012
Last Thursday, Mario Draghi the President of the ECB indicated willingness to start again his “asset purchases program”, baptized this time with the title of OMT (outright monetary transactions) a.k.a. issuing electronic money/credits to purchase the paper of troubled EU nations. The markets in the normal-abnormal reaction, received the news with excitement. Even that ill-conceived and ill-executed currency (Euro) gained relative to other major currencies!
All in all, Draghi’s move may have bought some time. After all, and as the quality of collateral is deteriorating worldwide, someone needs to be the buyer of last resort so that it could lease it back to the banks in another round of rehypothecation, so that more credit can be issued! In the medium and long term the OMT will backfire. We anticipate that Draghi’s move will be followed by a QE3 round in the US (as we wrote a few weeks ago), and in the short term that might prove to be profitable for the markets (possibly for equities and bonds, as well as commodities and other hard assets). However, in the medium and long term, and given the absence of quality collateral, the electronic money will be perceived as is, i.e. fiat money with no basis, and that will force institutional and individual investors to re-evaluate the situation, by dumping paper and seeking safe havens in hard assets, and primarily precious metals. The OMT will create asymmetrical risks and will misallocate fiat money if executed as advertised.
We are of the opinion that Draghi’s OMT program will try to rely extensively on moral suasion. After all, the diminishing returns of consecutive rounds of QEs will bring in a lot of pain if indeed go to the limit of “unlimited” and “indefinitely”. We believe that those two words are mostly used to deter bond sellers and to keep the spreads between German Bunds and peripheral countries’ yields within a reasonable range. However, there are other aspects of the OMT (as detailed by Draghi himself) that make us question its viability. First, he clearly wants those who ask assistance through OMT to be subjected to strict austerity conditions which in turn will be supervised by the IMF. Already the Prime Minister of Spain rejected the conditionality clause. Second, Draghi is planning to sterilize the OMT operations, something that may reduce real liquidity and thus backfire pretty quickly in terms of market confidence. Third, as investors start reviewing the QE rounds they will comprehend that they are nothing but competitive devaluations against real hard assets. We all know that competitive or collaborative currency devaluations lead to disaster. Fourth, the abstention of the German central bank implies that the most influential voice will not be silenced and while it may have lost a battle, the monetary warfare within the ECB will continue, shaking the bank and its moral authority. Fifth, political and legal challenges will slow down the implementation at a time when the available rescue funds are running pretty low. Sixth, old problems may resurface (such as Greece, Spanish banks, Spanish municipalities, lower output, higher unemployment, etc.) all of which will reduce the excitement and return investors to reality. Seventh, in the midst of a significant slowdown in China, the OMT does nothing for the real problem while tries to sugarcoat the ghost reality of an EU-wide banking sector that has transformed the dream into a nightmare.
I am just wondering: Wasn’t that chant “In Paradisum” composed for the dead? Don’t you think the Euro looks overvalued?