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Draghi: New Excuses to Increase Money Supply

September 26th, 2012 by Leonardo


This article was previously published in Italian as “Draghi: Nuove Scuse per Nuova Moneta” on 13 August 2012.

by Leonardo, IHC


Austrian (even some monetarist) economists believe in the following truth: printing money solves no problems, it can procrastinate them at best. Who knows something of Austrian economics, knows that printing will even worsen the problems re-occurring in the future and, however long this trick can work, a day comes when printing will make no effects thus the economy will crack.

The main problems on the desk today are public finances (both European and American) and robustness of the banking sector (officially linked to public finances problems, actually caused by easy lending policies of the past); as no one wants to face the problems as they are (which would mean cutting public spending and letting some banks default), the temporary solution to “pouring out more money” into the two sectors gets implemented. The point then becomes to find – i.e. print – further money: what has been done or proposed (EFSF, ESM with banking license, LTROs with low/lowering interest rates) goes accordingly, only with different justifications or “excuses”. The position expressed by Governor Draghi that the ECB will intervene directly in the govies market to restore the proper “transmission” mechanism of monetary policy is only the latest “excuse”.


The ongoing (since 2008) monetary policy is a chase for the best excuse to drown markets and banks with liquidity. It is not so different from what the world experienced during the 90s and the first decade of Y2K, only magnitude of interventions and urgent problems to solve have changed (in early years it was a matter of sustaining a certain positive rate of economic growth, while now there is a fight against a factual recession with States having already spent well beyond their budget limits). During the 90s, the negative effects of liquidity flooding were balanced by the positive effects of real supply-side shocks (internet and a lot of little, low-wage Chinese guys working in factories), Today a, call it, “compensating real factor” is missing; save the discovery of cold nuclear fusion or a Tesla’s energy generator, the only positive shock to expect can be the shrinking of the State with cutting public expenditure (welfare included as partly unequal and partly, simply, unsustainable) and fiscal burden at once – it is evident that no one “living on State money” (so many they are!) is willing to do.

Then, let’s go asking the ECB (in USA: the Fed) for more and more money! The first channel exploited is the classic funding to banks: ECB offering loans at improved conditions (lowering the interest rate), with increasing amounts (the ECB is currently lending unlimited amounts), and for even longer maturities (from the classical one-month lending to the recent three-years LTROs). The ECB has been using LTROs since 2009 with the interest rate already at only 1%. The point is that banks would get full of liquidity to even “being forced” to pouring it down to the real economy, as the banking sector is the main “channel of monetary policy” (as the American banking sector was in more profound troubles, the Federal Reserve went to directly finance  certain industries via bond purchases).

Once some “private” problems were transferred into public finances, and the problems of western economies’ welfare were manifest, further “new” money was asked for to fund public finances, so let’s go with ECB purchasing bonds and creating EFSF! You can push the problem a bit farther, then you find yourself deeper and deeper in troubles: by one hand, banks no longer invest the “new” money in the real economy but park it in the ECB’s deposit facility; by the other hand, the States keep on pile and pile up debt on debt (be it to save a sector or because of mere profligacy), so private savings no longer suffice to cover public and private needs (Austrian theories doceunt). Now the ESM looks necessary, funded with money that the States collect from a financial market which the ECB is providing with liquidity indeed. What will you do when you discover that all that printing is not enough to move the problems much away in the future (let alone to solve them)? You can propose the ESM to be provided with a “banking license”: as a “bank”, it can take part in ECB refinancing auctions, collecting unlimited amounts at a ridiculous interest rate (0.75% today). The ESM then can work as a running tap for a continuous liquidity flooding. Here a problem rises: a good part of Europe does not agree, probably understands that multiplying money means redistributing real purchasing power at their expenses; their veto can stop not only the “license” but even the EMS itself. Well now?


Here comes the Italian geniality of the ECB Governor. The Central Bank is not allowed for providing automatic help to public finances of whatever State (explicit for direct help – as to indirect help… absit iniuria verbis) but its mandate involves surveying the financial system as a channel of transmission of monetary policy (as said above) THEREFORE the ongoing crisis of public finances – weighing also on the balance sheets of banks then on their ability to lend credit – IMPLIES a problem of transmission of monetary policy, and as such it IS ECB’s business. The ECB must then be free to “print and buy”. Genius (I think Trichet would never have imagined it, not to mention Duisenberg)!

At the launch, these words has been welcome by markets, who clearly caught the message (newspapers, in the meanwhile, were insisting on empty sentences like “we’ll do everything possible” and “the Euro is not questionable”); then things have changed, as no one in the “high places” is really ingenuous and who is fighting against the banking license to the ESM  does not clearly want to be stealthy fooled out.


All this said, is Draghi’s position justified?

In a sense it is, as the ECB must actually (given its mandate) assure the proper (fluid and continuous) working of markets. If the interbank market locks (a liquidity crisis), banks will not lend to each other, then credit to clients will dry out and equity/bond markets lock; in such a case, the ECB shall provide markets with liquidity so that they can keep working as usual. Refinancing auctions are theoretically enough, but cases can occur when Quantitative Easing (purchasing bonds, thus direct funding, like in the USA) looks necessary. USA banks got mired with certain assets (remember the words “subprime” and “toxic assets”?) then the Fed re-acted by purchasing those assets away from the balance sheets of banks – the ECB has analogously bought some “Euro-periphery” assets. Once the problem is bought away, interbank market can – theoretically –  resume its previous working.

Anyway, this does not mean that banks have to buy such assets anew then invoke the help of the ECB again. In such a case, it is not a matter of interbank liquidity: we have a problem of incautious policies by banks! The locking of the interbank market would then be just a second round effect of a different origin, thus the systematic (unending) intervention by the Central Bank cannot be fully justified without – at least – specific measures on banks’ policies (defaults, recapitalisation, and so on). We must remember, though, that each State can exert some power (smart guys call it moral suasion) on banks, so it is a clear possibility to see the occurrence of an “entanglement” with States issuing more debt, banks forced to buy it, and the Central Bank funding these purchases or directly purchasing govies from those banks themselves; this would make the Central Bank protection of monetary policy channelling, actually, a quite direct subsidy to public expenditure – the greater the expenditure, the greater the subsidy.

Draghi’s position implies a trick which, reasonably, half Europe fights against.


Does this problem in the main monetary policy channel really exist? To size the question we can take a look at the deposit facility as money “printed” by the ECB but not used by banks; in a sense, it is a flowing back of the money poured down by the Central Bank. In mid-2012 the deposit facility amounted to the historical level of € 773 billion, which is more than a quarter ECB balance sheet (€ 3,000-odd billions) and 1.5 times the ESM “bazooka”. In these terms, Draghi seems somewhat right. But, alas, the deposit facility reached € 300 billion in early 2009, reached it again in mid-2010, then – after a new up-and-down – went to € 400 billion in 2011 and still rising. This “transmission” problem is not exactly new, then. I add: pre-crisis “normal” level was about zero. In 2009, with an ECB balance sheet of less than € 2,000 billion, the question was already worrying; moreover: these € 300 billion deposits amounted nearly as much as the net increase of money base during 2009, and the deposit facility jump of about € 300 billion during the first half of 2012 amounts to little more than the net increase of money base during the same period.

The situation may have well worsened, but it is in the end something ongoing for at least the last three years. Draghi’s warnings therefore are a bit late not to be considered simply as a hardly credible “excuse” to print further money.


The current “transmission” problem is not due to scarcity of liquidity but a matter of “solvibility” of the banking sector, which gets exploited to actually prop up public finances. The Central Bank’s accountability on “transmission” must not take shape as preservation of zombie-banks, not to mention being an excuse to keep up moribund Leviathan.


1 Response to “Draghi: New Excuses to Increase Money Supply”

  1. 1

    Leonardo Says

    Marginal corrections to English, sorry

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