11.15.2011 0

There are limits to what a central bank can do

By Robert Romano — “If a monetary deal’s going to work, the central bank has to have unlimited powers to intervene to support economies, and indeed banks, to prevent collapse.”

That was how the UK’s Business Secretary Vince Cable, a Liberal Democrat, put it on the BBC, speaking on the European Central Bank (ECB).  He was basically complaining that Article 123 of the Lisbon Treaty, which created the Eurozone, expressly forbids the ECB from making direct bond purchases of government debt.

Rarely are politicians so blatant about the pernicious practice that central banks engage in to prop up their host governments — i.e. print money to pay the debt.

While it may make one think of the historical examples of Zimbabwe or the Weimar Republic, the practice is actually incredibly common.  In fact, these examples pale in comparison to the largest debtor in history, the United States of America.

With a debt of over $14.979 trillion, the nation’s central bank, the Federal Reserve, holds $1.66 trillion of U.S. treasuries as of Nov. 9.  That’s more than 11 percent of the entire debt and growing, and is a larger share than either China or Japan hold.  We’re monetizing our debt, no question.

In fact, efforts by the Fed to hold down interest rates on treasuries have nothing to do with targeting unemployment or juicing growth.  The same can be said of Operation Twist, wherein the central bank is dumping short-term issuances and buying longer-termed bonds, bills, and notes.  These efforts have everything to do with keeping interest payments the federal government owes on its debts at manageable levels.

For example, if interest rates were to normalize over this decade to 5 percent, by 2021 the U.S. would owe $1.3 trillion annually in gross interest payments on a $26 trillion debt.  So, Bernanke wants to keep rates down, at about 3 percent or less, which would have the effect of bringing down interest costs to $780 billion in 2021 instead.

And that’s how the Eurocrats want the ECB to perform — as nothing more than a printing press to perpetually refinance the unsustainable debts of Portugal, Ireland, Italy, Greece, and Spain (PIIGS).  Their consolidated debts total more than €3 trillion.

Already, the ECB has bought €183 billion of that on secondary markets, or about 6 percent of the PIIGS’ debt.  This comes atop €78.5 billion of loans the International Monetary Fund (IMF) has also provided, plus the €440 billion European Financial Stability Facility (EFSF)

But keeping with its price stability mandate, every time it makes purchases, it removes a commensurate amount of money from the banking system.  For that reason, Rabobank economist Elwin de Groot says there is a “natural limit” of €300 billion that the ECB can take on.

Which means there is not much room left for the ECB to maneuver under the current regime.  In order to get around the Lisbon Treaty, it would need to be amended.  But the opposition to such a change is great — even from within the central bank.

“The eurosystem must not be a lender of last resort for sovereigns because this would violate Article 123 of the EU treaty. I cannot see how you can ensure the stability of a monetary union by violating its legal provisions,” said Jens Weidmann, head of Germany’s Bundesbank and ECB governor.

Which means that Europe is likely to unload its problems onto somebody else, likely the International Monetary Fund (IMF), which the U.S. funds 17.72 percent of.  The G20 recently agreed in principle to expand the IMF by as much as $350 billion to prop up Europe, according to Radio Free Europe.

Having already given $20 billion through the IMF to bail out European bankers that bet poorly on sovereign debt, that would raise the U.S. stake in the European bailout to $82 billion taxpayers’ money put at risk.

It is up to House Republicans to bring a stop to this, who promised in their Pledge to America they would “prevent Washington from forcing responsible taxpayers to subsidize irresponsible behavior by ending bailouts permanently”.  The American people remain deeply opposed to more bailouts, and Republicans must remember that was the issue that founded the Tea Party.

If the Europeans are unwilling to borrow and print more of their own money to prop up their own unsustainable debts, why should the American people be forced to do it?

Robert Romano is the Senior Editor of Americans for Limited Government.

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