27 Feb 2016

More detail about Draghi's €60 billion a month of money creation - and why he needs to change his methods

Following my other recent posts I'm getting increasingly interested in understanding the details of how Mario Draghi and the European Central Bank have decided to use their ability to create €60 billion a month until at least March 2017. A first point is that there are currently three different programs parts to its Expanded Asset Purchase Programmes (APP) :
  • the third covered bond purchase programme (CBPP3) which started in October 2014
  • the asset-backed securities purchase programme (ABSPP) which started in November 2014
  • the public sector purchase programme (PSPP) starting in March 2015
I've extracted the monthly status of all three programs from files that can be downloaded from the ECB's website and the results are shown in the following table.

As you can see, the ECB had already generated over €712 billion by the end of January 2016, with over three quarters of the money creation (over €544 billion) used for buying up public sector assets - essentially government bonds.  You can see that indeed, since March 2015, the ECB really has been buying up around €60 billion a month.

What possible benefits could these massive purchases have?

According to Mario Draghi, one beneficial effect of buying up bonds could be to reduce the cost of interest payments for governments. We have not yet access to the Eurostat figures on the cost of interest payments in the Eurozone for 2015 - these generally appear in mid April of the following year - see my analysis in 2012, 2013 and 2014.  But we can look at the how long term interest rates on public sector debts have evolved over the past year by looking at the ECB's own figures. The following table compares the rates for all Eurozone Countries in January 2015 and January 2016.

There are variations - but there are as many countries where the rate actually increased as there were where the interest rate dropped. There is thus no evidence that Mario Draghi's €544 billion in bond purchases has done anything to help governments.

I also got an email two days ago from the Banque de France in response to a mail in which I asked whether its bond purchases has had any effect on French Public Sector debt. The reply was clear - the Banque de France is completely independent of the Government, and so buying up bonds has no effect on Public Sector Debt.

Mario Draghi has also argued that buying up bonds and other assets can increase lending in the economy. But Frank van Lerven, who gave an introductory presentation on QE at the QE4People conference in Brussels last week (you can see his presentation here and he starts after about 5m:20), nailed that one on the head. He showed the results of the ECB's own Bank Lending Survey into whether or not the assets purchasing programme had been effective. Here's the slide.

I rest my case.

If governments get no direct benefit from all that freshly minted ECB money, and there is no improvement in lending into the economy by banks, who is benefitting?

To me, the answer seems clear. Since commercial banks have an effective monopoly on buying government bonds on the primary markets, and it is typically the same banks that sell to the National Central Banks via the secondary markets, it seems highly likely the the direct beneficiaries of the whole system are those commercial banks.

I would even go as far as to suggest that since commercial banks can create the money they use to purchase government bonds out of thin air, with no need for capital to back up those purchases (since government bonds are typically considered to have zero or very low risk), it is quite possible that the ECB's massive €60 billion a month program is going directly into the pockets of the commercial bankers.

I may be wrong. Maybe the National Central Banks are going through the Commercial Banks that are the secondary dealers to buy up bonds belonging to third parties - such as pension funds. But since the majority of those bond holders non-resident (62.8% of Negotiable French Debt for example, at the end of Q3 2015), it means that the ECBs cash injections could be ending up in the hands of US and Canadian Pension Funds. Again, it seems almost stupid to do things this way.

Many reputable economists are saying more and more loudly that Mario Draghi's methods for trying to get the economy moving are doomed to failure, and that he should start putting his €60 billion a month directly into the economy. Lord Adair Turner made a very strong case for such a change in his book "Between Debt and the Devil : Money, credit and fixing global finance". And just a couple of days ago, Martin Wolf, the chief economics correspondant of the Financial Times argued that "Helicopter drops might not be far away".

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