Tuesday, August 9, 2011

ECB Opts for Fool's Paradise

by Grant de Graf

The ECB has recently embarked on its own spending spree, a new strategy by the European Central Bank directed at buying up Italian and Spanish bonds, in an apparent attempt to comfort markets.

"The concept is to try and restore the normal functioning of markets through a better transmission of monetary policy, in order to ensure price stability," said ECB President Mr. Jean-Clause Trichet

The result is that bond yields in those countries have fallen, ostensibly an indication that objectives of the ECB have been achieved.

Somehow I am left with a familiar déjà vu, reminiscent of the 70s that saw a series of gold sale auctions by the Federal Reserve, in an attempt to contain the run away spot price. The result was that it had very little impact on the price of gold and in fact even accentuated its rise.

I am positive that the ECB will be successful in restraining bond yields in the short term, but in the long term the market is always much bigger than a government, a fact which the ECB has partially acknowledged. For example, Mr. Trichet has already stressed that confidence wouldn't return for good, unless governments demonstrate their commitment to stricter fiscal discipline.

However, what the ECB fails to appreciate is that failure to commit to fiscal disciple is a good way to destroy a country, but that implementing austerity, is not necessarily a good way to remedy the problems that have resulted from mismanagement, or even simply a consequence of the economy. Countries that face difficulty need well-defined programs that will encourage investment and job growth, a lesson that the United Kingdom and even the U.S. are learning. Simply applying a monetary policy initiative is not enough.

WSJ Assistant Managing Editor John Bussey explains the global impact of the European Central Bank purchasing Italian and Spanish bonds on a large scale. Photo: DANIEL ROLAND/AFP/Getty Images

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