Draghi Declares Eurozone Risk Premia "Unacceptable"

“The Governing Council extensively discussed the policy options to address the severe malfunctioning in the price formation process in the bond markets of euro area countries. Exceptionally high risk premia are observed in government bond prices in several countries and financial fragmentation hinders the effective working of monetary policy. Risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner. [What does “fundamental manner” mean in a case like Greece?] The euro is irreversible.

“In order to create the fundamental conditions for such risk premia to disappear, policy-makers in the euro area need to push ahead with fiscal consolidation, structural reform and European institution-building with great determination. As implementation takes time and financial markets often only adjust once success becomes clearly visible, governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist – with strict and effective conditionality in line with the established guidelines. [In other words, using the Greece/Portugal/Ireland template which includes deep structural reforms in addition to austerity.]

“The adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions. The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective.” [What objective?]

---Mario Draghi, President of the ECB: Introductory statement to press conference following the ECB board meeting:, Frankfurt am Main, 2 August 2012

Those are President Draghi’s words and my interjections. The reason his remarks seem to be inscrutable is because he wanted his remarks to be inscrutable. He used a lot of words to tell us almost nothing.

Draghi says that risk premia on government bonds resulting from fears of exit/default are “unacceptable”. Unacceptable to whom? Certainly not to real-money bond investors. Is he saying that the ECB will guarantee that such risks do not exist?, or that the ECB will take steps to reduce such risks?, or that somebody else ought to be doing something about it? He doesn't say.

Draghi says that such fears must be addressed in a “fundamental manner”. That can mean anything. Notice his use of the passive voice: “are unacceptable”, “need to be addressed”. This is like saying that catastrophic earthquakes are unacceptable and need to be addressed. I think what he means to say is that “risk premia that are related to fears of the reversibility of the euro are difficult for us to fix right now, and so they need to be addressed by the governments themselves by proving that they can implement the troika’s diktats to the letter and for years to come”. In other words, “the ball isn’t in my court”.

Then he goes on to articulate his conception of a third ECB mandate: That it will perform its policy duties toward countries only if they comply with third-party dictates. The analogy would be if the Fed were to condition monetary easing on US compliance with the IMF’s fiscal recommendations. No compliance, no easing.

Once again, Draghi appears to be picking up the hand grenade and tossing it back to the PIIGS. “If you lose weight and get exercise, then I will consider prescribing blood pressure medicine, but not before. Otherwise you’ll just go on binging on donuts and coke.”

What this means, on a practical level, is that Spain must formally apply for a bailout from the Troika. If she applies, and if the ECB thinks that she intends to comply with the Troika's diktat, then the EFSF and the ECB may resume buying Spanish bonds. How much, a lot or a little? Draghi: “of a size adequate to reach (our) objective”. What objective? Price stability? The elimination of risk premia? We don’t know because he doesn’t know: half of his board wants to rescue Spain and the other half isn’t so sure (see below).

So the guidance we have is that, if the Spanish government agrees to surrender fiscal sovereignty to the Troika (which it has pledged not to do), then maybe the EFSF/ECB will buy some amount of its bonds.

If Spain signs the surrender documents, the EFSF/ECB will probably buy some of itsbonds, the risk premia will stay up, and the ECB will say they did what they could. For the ECB to erase the risk premia it will have say that it is prepared to buy all of Spain’s debt. Well, how about that idea? Here’s one answer:

European Central Bank bond purchases won’t solve Spain and Italy’s difficulties maintaining investor confidence, ECB Governing Council member Luc Coene said in an interview with De Tijd and L’Echo.
Bond yields have been rising because financial markets don’t trust Spanish and Italian authorities to take the measures necessary to repair their economies, Coene said in the interview, published today in the two Belgian newspapers. As a result, he predicted few benefits from any ECB action.
“It makes no sense for the ECB to start financing those countries,” said Coene, who also heads Belgium’s central bank. “It would only lead to the ECB taking on the whole public debt of Spain and Italy onto its balance sheet. That would in turn weaken the ECB and do nothing to resolve the underlying problems".
--Bloomberg, Aug. 10th, 2012

So there you have it: from “whatever it takes”, to “how about this?” to “oh, just forget it”. 

Europe is now in suspended animation for the August holidays; nothing is supposed to happen until they are back next month.

The Trap Shuts On Germany

German politicians and former European Central Bank officials sharply criticized the ECB over the weekend and pushed for Germany, as the largest contributor to the euro zone rescue effort, to have more control in the central bank's matters, after President Mario Draghi signaled that the central bank could soon start purchasing government bonds.
"The new situation that Germany provides a growing share of the euro rescue, but has only one vote just like any other country no longer fits," Herbert Reul, a German politician and chairman of the Christian Democratic Union and Christian Social Union group within the European Parliament, told German magazine Focus on Sunday.
After resigning from the ECB last year in opposition to its bond buying program, former executive board member Juergen Stark warned in press reports that the further bond buys by the ECB would amount to "printing money," and risk increasing inflation.
While Germany holds 27.1% of the capital of the central bank, Executive Board Member Joerg Asmussen is the only other German on the 23-member governing council after Mr. Weidmann, who has just one vote.
In an interview with Focus magazine, Foreign Minister Guido Westerwelle said the problem is that "the economic and demographic weight in some committees and situations is not represented accordingly."
To strengthen the weight of the Bundesbank, Mr. Stark suggested to Focus magazine that the ECB remake its board, which today includes 23 members, to a nine-member board set up, where big member states such as Germany would receive a permanent seat and the other states would share the remaining seats.
That would require changes to both the Maastricht Treaty and the ECB's statutes, he noted.
--WSJ, Aug. 5th, 2012

There is nothing more amusing than an angry (but unarmed) German: “You cannot do this because I forbid it!!!”

Germany’s in a real pickle. She thought that she had joined a prestigious country club, only to be hit with a trillion euro assessment to repair other club members’ broken-down houses, and with only one vote on the board of directors.
I certainly sympathize with the Germans. They are the schmucks who always get screwed. They’ve been betrayed, cheated and swindled by France for two centuries, and now they find out that it’s just beginning. An analogy would be if  the Canadian taxpayer were told that he had to bailout the U.S. in the name of “North American solidarity”.

The Germans have unwittingly checked into the Hotel California.

"Relax”, said the nightman,

"We are programmed to receive.

You can check-out any time you like,

But you can never leave.”

What will the Germans do when they realize that they are trapped and that there will be no new treaties? It seems to me that there is nothing that they can do that isn’t radical. They are powerless with respect to the ECB. They had a veto over the ESM but they chose not to exercise it; Merkel has signed the agreement, the Bundestag has passed it, and the court will approve it.

However, this contretemps is occurring at a crucial time in German history. Today, 99.9% of German voters had nothing whatever to do with what went on during the war, and they are tired of being guilty for a crime they didn’t commit. They are no more going apologize for the Nazis than I am for the atrocities committed by the Eighth Air Force.

So I see younger Germans (who now include almost the entire political and economic leadership) wanting to act like a normal country with normal interests. Germany’s unrequited love affair with France is over.

Now, how Germany sees her interests and how I see them are different. They have an inflation phobia that is purely psychological. They would benefit, along with their neighbors, from 5-6% nominal GDP growth in the eurozone. The bogeyman of the ECB becoming Italian is nothing to be afraid of. Germany would lose some of its Germanness and some of its wealth, but none of its prosperity. Economic growth is much more important than having tons of gold locked in your vaults.

But I think we know that Germany is not about to have a Damascene conversion to inflation, open-ended bailouts and a weak euro, and that she will only play ball with Europe if she feels that she is in charge. Since she is not in charge, what will the Germans do besides getting angry?

Is The ECB About To Be Hijacked?

Draghi yesterday announced the ECB is working on a plan to re-enter bond markets and took the unusual step of naming Weidmann as the only policy maker to object to the proposal. While the move would ratchet up the ECB’s response to Europe’s debt crisis, it risks isolating the German central bank, potentially undermining the effectiveness of the new measures.

“That’s why investors are disappointed,” said Alexander Krueger, chief economist at Bankhaus Lampe KG in Dusseldorf. “The ECB can’t just take random measures against the Bundesbank’s will. The country with the largest economy needs to be part of any package.”

While Draghi’s comments suggest Weidmann has lost the support of traditional allies on the council such as the Netherlands, Luxembourg and Finland, the Bundesbank president may have German public opinion behind him.

While Weidmann only has one vote on the ECB’s 23-member council, “the Bundesbank veto matters a lot in this,” said Julian Callow, chief European economist at Barclays Plc in London. “We need to know exactly how the Bundesbank is appraising things.”

“We are the largest and most important central bank in the Eurosystem and we have a greater say than many other central banks in the Eurosystem,” Weidmann said in an interview published by the Bundesbank on Aug. 1. The ECB’s independence “requires it to respect and not overstep its own mandate,” he said.
--Bloomberg, Aug. 2nd, 2012

Clearly, the ongoing ECB power struggle is of great importance to those of us who prefer not to forage for their food. But there’s ethnic humor in it as well. Here you have Germany, founding member of the EU and the eurozone, drafter of the ECB’s statutes, stickler for rules, laws and treaties, airily announcing that the treaty establishing the ECB's governance is “only a scrap of paper,” to borrow a rather unhappy phrase from German diplomatic history*.

While each central bank has one vote on the ECB’s governing council, Germany believes that it has all the votes. You could spend a lot of time poring through Maastricht, Lisbon and the other governing treaties, but you won’t find that anywhere. What Germany says is incorrect, unless there is a secret codicil that says “Please don’t argue with the Germans”.

So Germany has now revised the ECB treaties to give the Bundesbank a veto over policy because “the ECB can’t just take random measures against the Bundesbank’s will”. I fully understand Germany’s frustration, but they signed the treaties. You can’t defend your position by reference to the same treaty that you have just denounced. Germany has no legal remedy within the eurozone to prevent the governing council from outvoting her. She stands alone against the entire council, without a veto. Germany can exit the eurozone, but she can’t kidnap Mr. Draghi and make him broadcast Bundesbank propaganda from Berlin.

What’s interesting about the ECB vote from a kremlinological perspective is that apparently no one voted with Weidmann including even his compatriot Joerg Asmussen. Not Finland, Netherlands, nor France. One can only conclude that the Bundesbank is indeed isolated, and one might even think that this is just the beginning of its isolation (especially given Asmussen’s apparent vote). We used to think of a “Northern League” of Germany, France, Finland, Estonia, Belgium, Luxembourg and Holland. They have all, with the exception of the Bundesbank,  deserted and voted with the impecunious Catholics in the south. 


Now, to be fair, it looks like the Bundesbank still has a lot of influence, in the sense that what Draghi was able to get passed was a lot less than he had promised. I guess the council members are still hoping to work out a deal with the Bundesbank that allows them to rescue Spain and Italy.
Nonetheless, Germany's increasing isolation could be very good news for the perpetuation of our global debt-financed Ponzi scheme. If the needy and the generous can hijack the ECB and make it print money, the eurozone crisis can be speedily resolved (and I will get creamed on my GLD and TLT).

Aside from the economic importance of this drama in Frankfurt, the theatrics will be fun to watch if you are into this kind of thing.
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* Statement by German Chancellor von Bethmann-Hollweg to British Ambassador Sir Edward Goschen, Aug. 4th, 1914, referring to the multipower treaty guaranteeing Belgian neutrality.

Why Stocks Keep Shrugging Off Bad News

An observer of the U.S. equity market would have to conclude that it has a strong bullish bias. Despite the weak economy, a clouded earnings outlook, persistently high unemployment and the European Sword of Damocles, the market shrugs off bad news and spikes on anything that can be construed as good news, no matter how tenuous.

The Fed fumbles the ball, the Bundesbank shows Draghi who’s boss, Southern Europe teeters on the brink of something awful--no problem! All news is good news. Girls just want to have fun and the market just wants to go up.

Why is this? Is the stock market irrational? Perhaps, but it is being paid to be irrational.

What is happening can be summarized in one well-worn sentence: Don’t fight the Fed. Since 2007, the Fed has: cut the overnight rate from 5.5% to near zero; grown its balance sheet from $800B to $2.7T; grown M2 from $7.2T to $10.0T ; and driven down 10-year Treasury yields from 4.6% to 1.6%. (For comparison, the Fed has bid up the PE ratio for Treasuries from 22 to 63, not exactly “value” territory.)

The Fed has systematically banged fixed income yields down to levels not seen in 50 years. The Fed is charging you for holding bonds and paying you to hold stocks.

At present, the forward PE on the S&P 500 is 13.3, the earnings yield is 7.5%, and the Equity Risk Premium (earnings yield minus bond yield) is 6%, which is very high. If you were a fiduciary (such as a pension manager), you would be hard-pressed to defend an overweight on fixed income when it yields nothing, versus equities that offer an attractive 7.5%.

The case for equities is compelling, and the relative “economic return” almost requires you to sell bonds and buy stocks. When stocks get this cheap, and bonds get this expensive, bad news has been fully discounted. Future news will have to  be really really bad to hurt stock prices.

To be bearish (like me), one has to expect catastrophe with a pretty high probability. A catastrophe that is bad enough to drive investors out of all risk assets and into Treasuries, and to keep them there by hitting the earnings outlook or cratering the financial system. 


We went through that exact scenario in the six months from September 2008 until March 2009, when the Dow declined by around 40%. That was because of a panicked flight to safety; it had nothing to do with relative yield. No equity market, no matter how priced, can withstand the risk of imminent financial collapse.

If an investor believes that Europe will figure out a way to save the eurozone, he should be in equities, because they are already priced for very bad news. If you believe, like me, that things will get much worse before they get better, then you should be underweight risk assets. But you will be taking a big risk that the world will not end this year.

The Dow has doubled since the crisis, and there has been an overhang of really bad things all along; the market has climbed a wall of worry. You therefore have to be both very cynical and very certain to believe that Europe will really blow up. But that is where my bets are.

ECB: Germany Wins, Europe Loses

Readers know that I had expected the Bundesbank to throw some bones to Draghi so that he could save face at today’s ECB board meeting. As far as I can tell, they gave him almost nothing. I had thought that he would be allowed to cut the overnight rate, offer a new low-cost bank loan program, and engage in bond-buying for “monetary reasons”.

What they allowed him to say was that, if and when Spain and Italy conclude austerity agreements with the Troika, then the ECB would be willing to buy their bonds in the secondary market in order to bring yields down. This is almost nothing. 


What Europe must have now is (1) massive quantitative easing in order to create inflation and grow nominal GDP; and (2) unconditional purchases of Spanish and Italian bonds until their yields are driven down to affordable levels. No more conditions, no more austerity. (That can be addressed after the crisis has been defused.)

Clearly, the Bundesbank drafted the ECB’s press release. It prescribes a full-fledged examination by the Troika in classic IMF style, imposition of a Troika-designed austerity plan that would not only cut budgets and raise taxes, but also require labor market and other structural reforms. As we have seen elsewhere, such programs are highly detailed and require a complete loss of sovereignty, something that both Spain and Italy have strongly resisted.

Instead of rescue by ECB printing press, Germany continues to offer rescue by draconian thrift, which the Italian and Spanish political systems are incapable of delivering. Neither country has any hope of being able to perform surgery on itself in the way that the Northern countries have done in the past. The German plan is based on the fallacy that after you have strangled the patient and destroyed his political system, he will be able to easily re-enter the debt markets at low yields. Markets just don’t work that way. These countries will be basket cases for years after the Troika is through with them.

There is only one way left to rescue the eurozone, and that is reflation, strong nominal GDP growth, and “fiscal monetization”. Only the ECB can deliver these goods. This will require the formation of a majority on the governing council to outvote the Germans and their Northern allies. Draghi is now irrelevant, having shown that he cannot bring the Germans around to his point of view. He represents no one.

Now the South must begin the process of (1) forming a pro-inflation bloc; and (2) wooing countries on the fence to turn their backs on Germany and vote with the bloc. Looking at the make-up of the governing council, it appears to me that a majority could be gathered for the anti-German position, as few countries stand to benefit from the failed German plan.

Once it is clear that the Northern bloc is going to lose, the Northern countries will have the opportunity to accept the outcome or exit the eurozone. I don’t think that any of them will exit (other than Finland), but if they do it will simplify things. The man in the middle is, of course, Hollande. If he is smart, he will join Club Med and escape from Merkel’s embrace. He has certainly sent signals along those lines.

The alternative to ECB rescue is chaos, default, and disorderly breakup.

ECB's Thursday Announcement: Standby for Euphoria

Seven hours from now, we will have the press release from the ECB board meeting, and then Draghi’s press conference. The markets wait with bated breath.

My expectation is that the ECB will announce three things:
1. A cut in the overnight rate from 0.75% to 0.50%.
2. Another LTRO (cheap money for three years) for the banks in the range of EUR 400-500B.
3. Revival of the SMP (bond buying) for “monetary reasons” in an unstated amount.

Another tranche of LTRO would be very helpful for Spain, coupled with the simultaneous EFSF recapitalization of its banks so that they are “solvent” for ECB lending purposes. That way, instead of the EFSF having to bail out Spain, the ECB can do it via the banks, which will use the funds to buy government bonds. The government can use the proceeds to pay its bills and fund the regions. This could keep Spain afloat pending the eventual startup of the ESM.

Reviving the SMP could have substantial influence on market sentiment as it hints at an eventual ECB rescue of Spain and Italy. But it will be purely symbolic.

Thus, the ECB can throw up enough dust and confusion to convince the markets that it will do “whatever it takes”, and thus redeem Draghi’s exigent promise. Audible relief all around, and then everyone in Frankfurt and Brussels can go off on their August holidays. There should be sufficient confusion and misdirection for the bullish to declare victory as they are wont to do whenever the sun rises in the morning.

However, what will be  missing in this excitement  is the fact that no part of the Troika has visited Spain to conduct an on-site examination of its banks or its regions. All we have today are two consulting firms’ estimates of the size of the banks’ asset quality problem. I sincerely doubt that they provided in any way for the impairment of the banks’ loans to the autonomous regions, all of which have lost market access and all of which are running operating deficits. I also doubt that a bunch of European consultants (no offense) have the slightest ability to do the down-and-dirty on  the banks’ commercial real estate portfolios.

Those who haven’t lived through a real estate disaster may have trouble understanding that many such loans are worth not 85% or 75% or 70% or 50%, but nothing as in nothing. Raw land and unleased (or half-built) structures can be worth nothing. All those half-built condos on the Costa del Sol? They are probably worth less than nothing. They will stand as monuments to what might have been.

The regions have big deficits and can’t borrow in the markets, which means that their debt  should be consolidated with the government, along with the gaping hole in the banking system. The cost of a full bailout of Spain will be much more than currently anticipated, and it will manifest itself over the next few months. But it will take a few weeks for that to sink in, after everyone is back at work in September.

Draghi Was Speaking Without German Authorization

Last week, Mario Draghi said that the ECB would do “whatever it takes” to save the euro, which was widely interpreted to mean that the ECB would intervene in the bond market to bring down Spanish and Italian bond yields. Following his statement, the Dow rose by over 500 points, reflecting the market’s expectation that the ECB will rescue the eurozone.

Readers will recall that I said to ignore anything Draghi says unless it is followed up by support from the German finance ministry (Schauble) and central bank (Weidmann). Now the evidence is in: Draghi was speaking without German authorization (see below).

Draghi’s statement has no information value unless it is predictive of future ECB policy, and I don’t see that we know anything more about ECB policy than we did before he spoke.

There will be no deus ex machina from the ECB until he can persuade Weidmann, Schauble, Merkel and the Constitutional Court (i.e., Germany) that this is both legal and desirable. That may still occur, but it hasn’t happened yet. Once this fact sinks in, I expect that the stock market's balloon will start leaking air.

I emphatically agree with Draghi that a rescue mission is required, but he is not in charge of the ECB and the markets need to absorb that fact.


Wolfgang Schauble, German finance minister:
(Seeking Alpha newswire, July 29)
German finmin Wolfgang Schaeuble rejected speculation that Spain is about to request that the eurozone's bailout fund [EFSF] buy its bonds. While the country's high interest rates are "painful," it is "not the end of the world if you have to pay a few percent more at a few bond auctions," Schaeuble told the Welt am Sonntag newspaper.

Deutsche Bundesbank:
(Reuters, July 27)
Germany's Bundesbank dampened expectations for further action by the European Central Bank on Friday by upholding its resistance to the ECB buying bonds, a day after ECB President Mario Draghi raised expectations such a move could be on the cards.

Draghi sent a strong signal to markets on Thursday that the ECB was preparing further policy action, saying that the ECB was ready, within its mandate, to do whatever it takes to preserve the euro, referring also to inflated borrowing costs, which some saw as a hint the bank could revive its bond purchase program.

The Bundesbank, which opposes the ECB's Securities Markets Program (SMP) because it treads too close to the central bank's ultimate taboo of state financing, said on Friday it was still not in favor of such a step. "The Bundesbank continues to view the SMP in a critical fashion," a Bundesbank spokesman said "The mechanism of bond purchases is problematic because it sets the wrong incentives."

ING economist Carsten Brzeski said Draghi's words were interpreted too enthusiastically, and he should have maybe been more careful. "Bundesbank comments are confirmation that this is not going to happen, that the ECB is not going to play Santa Claus."

Eurozone: Ignore Whatever Mario Draghi Says

“Within our mandate the ECB is ready to do whatever it takes to preserve the euro and believe me: it will be enough.”
--Mario Draghi, July 26, 2012

So, is the eurozone crisis over? Do Draghi’s remarks today mean that the ECB has capitulated to the South, and will now buy Spanish and Italian bonds without limit until their yields come down? Is it time to sell bonds and jump back into the equity market with both feet?

In a word, no. We need to learn to stuff cotton into our ears whenever a non-German eurozone official is speaking. Unless you hear this kind of talk from Jens Weidmann, head of the Bundesbank, it is meaningless.

So far, we have had heard, in addition to Draghi,  officials from Austria, France, Italy, Spain and Belgium, statements endorsing an ECB rescue of the eurozone. We have heard no such statements from Finland, Holland or Germany.

Draghi may be one of the smartest people in Europe, but he is stuck in a no-win situation. If he does not act, the eurozone will blow up and he will lose his job. If he acts (with a working majority), Germany will go ballistic. He knows this, which is why his remarks* were so carefully crafted.

Draghi began with the bald statement above (“whatever it takes”) and then, later on, he walked back by saying “whatever it takes within our price stability mandate”. “Whatever it takes within the price stability mandate” is dramatically less than “whatever it takes”. He then goes on to list all the things that the ECB can’t do, such as lending to insolvent banks or buying bonds of non-compliant governments.

Basically, Draghi believes that he can lend to compliant governments and solvent banks in order to preserve the transmission mechanisms of monetary policy.

The fact that the North is doing well and the South is in a depression suggests that those transmission mechanisms no longer exist. Right now, Europe has two different eurozones, one where everything is working and one where nothing is working.

I will believe Draghi if and when (1) Weidmann says something similar; and (2) the ECB moves into the Spain/Italy bond market with overwhelming force and absolutely destroys the shorts (say, yields dropping below 4%). I do not expect either of these to occur, or at least not until we are closer to the edge of  gotterdammerung.

And furthermore, not only will the ECB not do whatever it takes, it will not even do whatever it takes within its mandate unless Germany agrees. Weidmann is very close to Merkel, so I believe that when he speaks, he is speaking for Germany.

The ECB governing council meets in one week. Between now and then, Weidmann or Schauble will say something relevant. Those remarks will be much more telling than anything Draghi says. Then, the ECB will have to craft its press release next Thursday. That will be the dispositive event. If it mentions yield-targeting for Spain and Italy, Draghi has won. If it doesn’t, Weidmann has won.

I am personally light equities and long Treasuries (TLT) and gold (GLD). If Weidmann wins, it’s bad for the world, but I will make some money. If Draghi wins, I am badly positioned. But I think I’m OK, at least for now.
______________________________________________________________
*Draghi’s remarks:
http://blogs.wsj.com/economics/2012/07/26/key-excerpts-mario-draghi-says-ecb-ready-to-do-whatever-it-takes/

The Wall Street Journal offers Spain some advice

The ECB shouldn't be acting as a crutch for ineffective national governments... Spain's crisis is Madrid's, not Frankfurt's, to resolve...Spain's political class is still goading Europe's central bank to do more. Without more labor-market reform and reductions in its swollen government, Spain will soon be back to Brussels with the begging bowl.

--WSJ editorial, July 24, 2012

The WSJ has been consistent in its support for hard money for over a century. As readers know, I am a soft money man right down to my toes. I wouldn’t blame the Journal for being consistently on the wrong side of history if they were just a voice in the wilderness. Unfortunately, a whole lot of important Republicans (and regional Fed presidents) believe that the Journal knows something about monetary policy, and parrot its quack nostrums and remedies as gospel. (These people worship Milton Friedman but have never read him.)

In my opinion, most of the world’s problems have been caused by hard money men and their camp-followers. Certainly every depression in world history has been caused by hard money. By hard money I mean deflationary policies caused by either inadequate money growth or, worse, a contraction in the money supply. Two classic (and self-inflicted) examples are: the deflation pursued by the US after the Greenback Era to resume gold convertibility at the prewar ratio; and the deflation pursued by the UK after the Great War to resume gold convertibility at the prewar rate. Both countries got the depressions their hard money men had desired.

Another of the world’s great self-inflicted depressions is happening right now, in the eurozone. In order for the southern members to stay on the euro, they are being forced to deflate just as much as if they were on the gold standard. Brussels’ tough-love prescription for them is to keep cutting spending until their expenses are as low as their ever-falling revenues. As their revenues decline, the more they have to cut. If revenue goes to zero, they will have to cut everything--but DO NOT PUSH THAT DEFAULT BUTTON! We’ll be sure to lend you just enough so that you don’t do that. Your people can starve in the streets, but don’t default. That would be disruptive and “bad for Europe” (cross yourself after saying that).

None of this would be happening if Europe had a responsible American-style central bank with a mandate to avoid depressions. If your mandate is to maximize employment, and some regions are experiencing up to 25% unemployment, you might be undershooting your employment target. And if your mandate is growth with moderate inflation, and your economy is in reverse and there is no inflation, you might want to touch the accelerator just a bit, rather than looking out the window and 
saying “I’m doing everything I can”.

No government in the world, no matter how "responsible" its policies, can engineer prosperity with an incompetent central bank. Right now all of the developed world’s major central banks are at best negligent. Their nonfeasance ranges from the catastrophic (BoJ, ECB), to the dangerous (UK), to the inadequate (US). And they are all pursuing hard money policies with low inflation and low growth. And they are all “doing everything that they can”.

So, in the opinion of the hard-money boys at the WSJ editorial board, Spain’s current depression is caused by inadequate “labor-market reform” and a “swollen government”.  Labor market reform won’t have any impact on Spain's debt-ratio arithmetic, and Spain’s government spending is declining at an annual rate of 5%. Not only isn’t its budget swollen, but cutting it further won’t make the slightest difference. Spain is running out of money, but not out of useless advice from Paul Gigot.

Spain is at a crossroads: it must either fix its central bank or get a new one.

Spain has a big deficit, billions of maturing debt into the horizon, no market access and an indifferent central bank. That is not sustainable, because she is running out of money (what economists call a "hard constraint"). Another handout by the Troika will be very costly, will add to Spain's debt, will annoy the German public,  and won’t solve anything. Spain’s money needs to come from a printing press. If the ECB stepped up and did its job, the crisis would be over and the Dow would go up by 3000 points. Otherwise, Spain will have to follow Greece with all that that implies for the world as we know it.