Wednesday, December 28, 2011

ECB's "liquidity injections" just reinforcing deflationary forces already in place



The ECB's balance sheet (total assets) is now up to $3.5 trillion. That's 25% larger than the Fed's. (All this "money printing" eh? So where's the inflation? Why is gold falling?)


When the ECB expands its balance sheet, it buys bonds from the public and replaces those bonds with reserves (denominated in euros). Those reserves pay 25 basis points, however, the bonds paid far more. (Case in point: Italian bonds pay near 7%.)

So you can see how this “liquidity” operation is stripping a HUGE amount of interest income from the private sector in Europe. HUGE! If you sold an Italian bond to the ECB you just lost 675 basis points of income!

So rather than being inflationary or “stimulative,” the whole thing is massively deflationary because of the interest income reduction that is going on. This will exacerbate already weak economic trends in the Eurozone in 2012!


6 comments:

Anonymous said...

Since Im a newbie and not a trader or anything (just an MMT fan)...

Why would someone sell it to the ECB rather than get their 7%?

Matt Franko said...

Anon,

Austerity is perhaps causing non-govt entities to liquidate assets to live. So they sell bonds to get balances to exchange for goods...

Banks balance sheets are only so big so they cant buy them all...

MF Global got burned trying to buy the sovereigns and they moved against them and they got closed out and bankrupted....

It's a mess... seems like folks are liquidating and are going to balances in the bank.

Resp,

Dan Kervick said...

"So you can see how this “liquidity” operation is stripping a HUGE amount of interest income from the private sector in Europe. HUGE! If you sold an Italian bond to the ECB you just lost 675 basis points of income!"

On the other hand, nobody forces these folks to sell their bonds to the ECB, do they? If people are willing to sell them, that must be because they see some benefit for themselves or their institutions in the sale, and prefer the liquidity plus lower interest now rather than the higher interest later.

Matt's explanation sounds reasonable, in which case this is a bad thing - an austerity-induced fire sale.

Ron T said...

If you lose the interest income, why would you sell the bond for reserves?

Игры рынка said...

Yes, but the base of calculation is not 3 trln. Liquidity injections in eurozone are done on collateralized basis and not on asset purchases basis (OMO). ECB has bought just 200bn so even 7% is pretty much nothing in the scale of eurozone.

Mike Norman said...

Even if total purchases are $200 bln, it's still stripping income from the private sector.

As to the question of "Why would anyone sell?"

Various reasons.

The main point is, there's always a supply of bonds being sold/traded in the secondardy market. The ECB just buys up whatever it needs to keep rates where it wants them. No one is forced to sell, but buying pretty much any quantity of eurobonds is fairly easy for the ECB and becoming more and more routine.