The problem with European monetarism is not that it is trying to swim against the tide of fragmented “markets” and national boundaries that represent very real hurdles in terms of legal and systemic bottlenecks. For the most part, everything that the ECB has tried, including a great deal that predates the bright spotlight on Mario Draghi, has led to precisely nowhere. While that is categorical in terms of the larger goals of an actual economic recovery, rather than the gloss of positive numbers that represent(ed) just the absence of further contraction, that does not mean that there has been no effect upon wider financial Europe.
Indeed, the most significant aspect of repeated European monetarism has been the grotesque debasement of sovereign debt markets, including those “central” to Europe. Low interest rates and spreads dominate across the continent, leaving the impression that there is little risk in the current circumstance to banks.
It was the banking sector in Europe that was “pulled” into Draghi’s great 2012 promise to save the euro at all costs. Rather than unleashing a tide of “animal spirits” instead was a massive and artificial wave of sovereign debt buying to both express disgust at actual European economics and a nod toward “capital” shortfalls. That presents a risk to further economic erosion in Europe as the banks there are overexposed to anything approaching a return toward 2011.
You would expect such empirical reality to form a full part of the ECB’s latest stress tests, given both recent history and that bank exposure. As is usual, however, the stress tests themselves are designed to be nothing but “reassuring”, as was the case with prior episodes. The problem with creating a test that nobody can possibly fail is that credibility is lost very quickly, so the challenge this time was to create “failures”, but those that were largely cosmetic and easily withstood.
So the “adverse scenario” of sovereign bond yields leads to a situation where most simply return to where they were in December 2013 – not even December 2012, let alone the worst of the worst in July 2012. As is shown above taken directly from the ECB’s slide deck presentation for the stress test results, on average the “adverse 2016 scenario” is for sovereign yields to rise less than they have fallen since December 2013.
The pervasion of circular logic in that is par for the central bank course, in that the truly adverse scenario, a repeat of what actually happened in 2011 and 2012 is just a trivial concern because the ECB now operates the unspecified and unchallenged mantra of “do whatever it takes.” However, the truly adverse scenario is one where that “promise” loses all credibility as it combines directly with obvious impotence (and thus desperation) to actually accomplish anything in the real economy. That is what makes a re-re-recession all the more dangerous in this financial context.
What might Italian or Greek yields become if faith in the ECB no longer applies in even a small number of banks? Selling would quickly turn to a hair trigger as there is nothing truly fundamental about those yields.
I don’t think any of that is surprising given how little credit markets have reacted to the stress test results this weekend. Despite last week’s chatter, European bond yields are almost totally unchanged from Friday; which were largely unchanged from the week before. In that sense, the stress tests were more likely to ignore anything outside of “real” failure in an actually credible range of adverse scenarios – credit markets are focused on the true culprit in Europe.
The overriding problem continues to be the European economy, despite trillions of euros and countless redistribution attempts (one that succeeded in only reconstituting bank behavior from lending to exclusively government bond buying). Liquidity is not the answer, but that is all the ECB has to offer, even if it becomes more “targeted.” Economic expression is what is moving “markets” if only from the perspective of Draghi’s promise set against growing realization of monetary failure. The reignited interest in all things Swiss franc denominated (or of German government issue) is the confluence of that economic incapability running toward an eventual and potentially dangerous test of ECB resolve – including to actually handle, should it be necessary, rising PIIGS yields once more.
Yet, that was the one aspect the ECB could never actually test as it would represent forewarned admission of failure for the whole “recovery” period – if they stress tested much higher and more realistic sovereign debt yields it would supersede all other negative factors in saying that even the ECB might not believe that government bond yields are anything but artificial like their economies. So they had to “pretend” the worst case scenario is last December, ignoring all else as if were nothing but a one-time bad dream. The problem is that everything in the European real economy might actually foretell the opposite; thus the stress tests are treated as irrelevant and a non-event.
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