Editor’s note: This post was first published on Ello on January 19, 2015, before the ECB QE announcement on Thursday.
Last Friday Der Speigel published details of possible ECB QE modalities. This post takes the report at face value and looks at what the sovereign purchase plan might mean.
Firstly, ECB QE with national central banks (NCB) buying only their own sovereign’s debt does not end risk sharing. When a NCB purchases anything outright, it creates euros. Those euros are a eurosystem liability. That’s a pretty fundamental part of being in a monetary union.
So, is the NCB QE plan a political sop to ease (mostly German) worries? And as such, is it meaningless to the effectiveness of the plan? After all, QE is QE.
Most of what I have read so far on this points to it either being meaningless, or worse, a watering down of QE.
Having thought about over the weekend, I’ve come to the conclusion that NCB QE is actually likely to be more effective than ECB level QE.
The template for this is the Irish Central bank’s unwind of its ELA with the now defunct Anglo Irish Bank. It was a but of a three card trick, so worth going through to see similarity.
Anglo Irish Bank was a nationalised bank that was completely bust after the ending of the Irish property bubble. In order to keep the zombie animated (in order to avoid a dis-orderly default) the Irish central bank provided over €40 billion of emergency liquidity (ELA) to Anglo. This ELA was backed by an instrument called a ‘promissory note’ issued by the Irish government.
The arrangement in place was that the Irish government would pay the promissory note over ~10 years, paying €3.06bn annually to the Irish central bank.
So, for all purposes, the promissory note was sovereign debt on balance sheet of the Irish central bank, as it was the collateral backing ELA – ELA which Anglo Irish bank had no hope of ever paying.
In February 2013, the Irish government took the decision to wind up Anglo (by this time it was called IBRC). This meant that the Irish central bank’s ELA counter-party no longer existed, so it needed to get the ELA covered. The Irish government covered the ELA by giving sovereign bonds to the Irish central bank.
Now, as Anglo was an arm of the Irish state (as a nationalised bank), so we can simplify and retell that story like this: Irish central bank accepts promise from arm of Irish state in return for euros. Arm of Irish state defaults, so Irish central bank accepts another promise from Irish state in lieu of repayment of euros.
All of which means if an NCB buys the debt of its sovereign and when the time comes for repayment it can (under the above precedent) accept new sovereign debt in lieu of repayment. Even more importantly, the Anglo precedent means that even if a euro member state defaults (as Anglo effectively did) then there is no reason the NCB cannot replace the defaulted bonds on its balance sheet with new sovereign debt.
This scenario can only arise under an NCB QE operation. If the ECB is the holder of the sovereign debt, then it will – as Greece knows well – always insist on full payment.
If you had to pick a QE, surely the one with zero default cost would be the better one.