So What Did the Central Banks Do Yesterday?

      Ok, so a day later how does yesterday's coordinated action by the central banks look? Initially judging by the reactions of world markets it seemed pretty good. And Scott Sumner had said something about improved Treasuries yesterday morning.

      http://www.themoneyillusion.com/

      Still more skeptical voices have emerged. In a post today over at Naked Capitalism Yves Smith has a post entitled "Does Anyone Who Gets it Believe Central Banks Did All That Much Yesterday?"

      http://www.nakedcapitalism.com/2011/12/does-anybody-who-gets-it-believe-central-banks-did-all-that-much-yesterday.html

      Well I don't know if I'm one who totally gets it. Whatever it is they did sounds kind of impressive and the markets liked it though of course the equity markets are not what counts-the bond markets are. Yves mentioned that "as readers pointed out in comments, the big move was overnight, in futures, when trading is thin, and there was no follow through when markets opened. And volume was underwhelming."

     But measuring the overnight futures after a huge 5% move is not necessarily any more reliable gauge than the initial move itself-again the important moves are ultimately in the bond market. As Sumner liked the move let's see what he said:

     "It’s much too little, but not at all too late.  (No such thing as long and variable lags.)"

      So he isn't necessarily saying they did "all that much" either. But that it is something and this something is not too late. Still Yves is able to quote a number of commentators who do get it who are not so impressed.

      "So this looks to me like a non-event. Yet markets went wild. Are they taking this as a signal that substantive actions — like the ECB finally doing what has to be done — are just around the corner? Are they misunderstanding the policy? Was this cheap talk that nonetheless moved us to the good equilibrium? (If so, not enough: Italian bonds still at more than 7 percent)."

     Tony Crescenzi at Pimco focused on the litmus test: if the ECB isn’t changing posture, this was all a big head fake. Only the ECB can provide a real stopgap, and only far reaching changes (both some sort of fiscal authority and addressing internal imbalances) will provide a solution:

     "The provision of liquidity is no substitute for other actions that Europe must take to solve its current woes. The world continues to wait on European actions on fiscal rules, discipline, and enforcement, as well as use of the balance sheet that matters most in the current situation: the European Central Bank."

      As Yves points out, "Even the normally discreetly cheerleading New York Times was up front in saying that this move was at best an expedient:

     "But policy makers and analysts were quick to caution that the Fed’s action did not address the fundamental financial problems threatening the survival of the European currency union. At best, they said, efforts by central banks to ease financial conditions could allow the 17 European Union countries that use the euro sufficient time to agree on a plan for its preservation."

     “The European sovereign debt problem will not be solved only with liquidity,” the governor of Japan’s central bank, Masaaki Shirakawa, told reporters in Tokyo. He said that he “strongly” expected Europe to “push through economic and fiscal reform.”
 
      "European leaders, increasingly concerned by a deteriorating financial picture, said Wednesday they were forming a plan to convince markets that the debts of nations like Italy and Greece were not overwhelmingly large and to set new rules to constrain borrowing by euro zone members. They pointed to a scheduled meeting in Brussels on December 8-9 as a looming deadline for those efforts."

     "The provision of liquidity is no substitute for other actions that Europe must take to solve its current woes,. The world continues to wait on European actions on fiscal rules, discipline, and enforcement, as well as use of the balance sheet that matters most in the current situation: the European Central Bank."

      Yves elaborates on what the move was meant to communicate to markets: " the action was really not about the reduction in interest rates on the dollar swap lines (Krugman correctly points out it really doesn’t mean much) but that the system was visibly seizing up, and the authorities were telling the markets they were on the case. But this needs to be put in context: this is giving a probably dying patient emergency oxygen when he needs to be put in intensive care."

    She then quotes Roubini who she says is back to being very good, "another sign we are in crisis mode."

    "With public debt at 120 per cent of gross domestic product, real interest rates close to 5 per cent and zero growth, Italy would need a primary surplus of 5 per cent of gross domestic product – not the current near-zero – merely to stabilise its debt. Soon real rates will be higher and growth negative. Moreover, the austerity that the European Central Bank and Germany are imposing on Italy will turn recession into depression…"

    "Even if austerity and reforms were eventually to restore debt sustainability, Italy and countries in a similar position would need a lender of last resort to support them and prevent sovereign spreads exploding while they regained market credibility. But Italy’s financing needs for the next twelve months alone are not confined to the €400bn of debt maturing. At this point most investors would dump their entire holdings of Italian debt to any sucker – the ECB, European Financial Stability Facility, IMF or whoever – willing to buy it at current yields. If a lender of last resort appears, Italy’s entire debt stock of €1,900bn will be soon supplied."

    "So using precious official resources to prevent the unavoidable would simply finance the exit of others. Moreover, there is no official money – some €2,000bn would be needed – to backstop Italy, and soon Spain and possibly Belgium, for the next three years."

    "Even current attempts to ramp up EFSF resources from the IMF (which is reportedly readying a €400bn-€600bn programme to backstop Italy for the next 12-18 months), and from Brics, sovereign wealth funds and elsewhere, are bound to fail if the eurozone’s core is unwilling to increase its own contributions, and if the ECB is unwilling to play the role of an unlimited lender of last resort…."

    "So Italy’s public debt needs to be reduced now to at worst 90 per cent of GDP from the current 120 per cent…There should be a credible commitment not to pay investors who hold out against participating in the offer – even if this triggers the payment of credit default swaps."

     "With appropriate regulatory forbearance, it would allow banks to pretend for a while that no losses had occurred and thus give them more time to raise fresh capital. Since about 40 per cent of Italy’s public debt is held by non-residents, a debt restructuring will also imply some burden sharing with foreign creditors."

     But this "credible commitment not to pay investors who hold out against participating in the offer" Yves says is unlikely to be shown: "Since we seem to have an international policy of “bondholders take no losses until the situation becomes completely untenable,” I don’t see a sensible resolution in the offing. The European leadership has lurched from stopgap to stopgap to avoid taking tough action. Now that the crisis is upon them, badly ingrained habits and tight timetables argue against happy outcomes."

     The thing that seems to work against the EU is time. They come to any right solutions only belatedly. They should be acting as if their house is on fire-because it is. If there is any good news today it's that the French and Spanish had very successful bond auctions today.

    "Madrid's cost of borrowing—ranging from around 5.19 to 5.54 percent on the 4-, 5- and 6-year paper—was the highest at a government sale since before the launch of the euro, but far below yields around 7 percent widely held as unaffordable."

    "It is only two weeks since Spain auctioned 10-year debt days before a general election that swept a new center-right government to power, and saw yields hit euro-era highs of 6.975 percent."

    http://www.cnbc.com/id/45505203

     France saw it's yield relative to German yields drop to 93 basis points, its smallest spread in a month. Still again what is clear is that more needs to be done as the many commentators quoted above argue:

    "while yields on Spanish bonds have fallen this week, they will probably not come down more substantially until clear decisions are announced to tackle the crisis."

    "Most market players say that still adds up to the European Central Bank stepping in to backstop struggling governments—something it and Germany continue to resist strongly."

    "Unless there's a sign central banks are coordinating and are prepared to do more fundamentally, is there really much to get excited about? Probably not, unless it's backed by something else," said Marchel Alexandrovich, economist at Jefferies.

    So what does yesterday's moves amount to? At best the hope is that it implies that more will be done. As the Wall Street Journal explains today on pg. A14 "The move is more of a pressure-release valve than a direct action, and doesn't do anything to address underlying problems in Europe. By making it cheaper and easier for European banks to access other currencies, it reduces pressure on markets while policy makers search for a solution."

    And why were the markets "so cheered"?

    "Although the announcement didn't alter any of the fundamental problems, it signals that central banks are coordinating and prepared to act in the event that conditions worsen."