By Alasdair Macleod *
Like the Fed, the ECB is resisting interest rate hikes despite soaring producer and consumer prices. Consumer price inflation in the Eurozone was recently recorded at 4.9%, bringing the real yield on the German 5-year bond to minus 5.5%. But German producer prices for October were up 19.2% from a year ago. There is no doubt that producer prices have not yet been fully integrated with consumer prices, and the rise in consumer prices has yet to go further, reflecting the acceleration of currency depreciation. of the ECB in recent years.1
Therefore, in real terms, not only are negative rates already rising, but they will go further into record negative territory as a result of rising producer and consumer prices. Unless it abandons the euro completely to its fate on foreign exchange, the ECB will be forced to allow its deposit rate to rise from its current —0.5% to offset the depreciation of the euro. And given the magnitude of recent monetary expansion, euro interest rates will need to rise significantly to have a stabilizing effect.
The euro shares this problem with the dollar. But even if interest rates rise only in slightly positive territory, the ECB should step up the pace of its money creation just to keep heavily indebted eurozone member governments afloat. Foreign exchange is required to recognize the development of the situation, punishing the euro if the ECB does not raise rates and punishing it if it does. The fall of the euro will not be limited to exchange rates against other currencies, which face to varying degrees with similar dilemmas, but it will be particularly marked in relation to the prices of raw materials and basic necessities. It can be argued that the downgrade of the euro on foreign exchange has already started.
But there is an additional factor that is not generally appreciated, and that is the sheer size of the euro repo market and the danger of rising interest rates. The demand for collateral against which to obtain liquidity has led to significant monetary expansion, as the repo market does not act as a marginal liquidity management tool as in other banking systems, but as a source. accumulated credit. This is illustrated in Figure 4, which is an ICMA survey of 58 leading institutions in the euro system.2
The total of this form of short-term financing increased to 8.31 trillion euros in contracts outstanding in December 2019. The guarantee includes everything from government bonds and bills to prepackaged commercial bank debt. According to the ICMA survey, double counting, in which pensions are offset by reverse pensions, is minimal. This is important when one considers that a reverse repo is the reverse of a repo, so that with pensions that are in addition to registered repurchases, the sum of the two is a valid measure of the repo. size of the repo market. The value of pensions negotiated with central banks as part of official monetary policy operations was not included in the survey and remains “very significant”. But pensions from central banks in the normal course of financing are included.3
Today, even excluding central bank repos linked to monetary policy operations, this figure almost certainly exceeds € 10 trillion by a significant margin, given the monetary expansion accelerated since the ICMA survey, and when we admit participants beyond the 58 dealers listed. An important part of this market are interest rates, which, with the ECB’s deposit rate standing at minus 0.5%, means that Eurozone liquidity can be obtained freely by banks at no cost.
The zero cost of repo cash raises the question of the consequences if the ECB’s deposit rate is brought back into positive territory. The repo market is likely to contract in size, which is equivalent to a decrease in outstanding bank loans. Banks would then be forced to liquidate assets on their balance sheets, pushing all negative bond yields into positive territory, if not more, further accelerating the bank lending contraction as collateral values collapse. Moreover, the contraction in bank credit implied by the withdrawal of repo funding will almost certainly have the ripple effect of rapidly triggering a liquidity crisis in a cohort of banks with an unusually high debt ratio.
There is another issue to consider regarding the quality of guarantees. While the US Fed only accepts very high quality securities as a pension collateral, along with the Eurozone national banks and the ECB almost everything is accepted – this had to be when Greece and the other PIGS were bailed out. . And the hidden bailouts of Italian banks by bundling bad loans into pension guarantees was how they were wiped from national banks’ balance sheets and hidden in the TARGET2 system.
As a result, the first repos not to be renewed by commercial counterparties are those for which the collateral is bad or doubtful. We don’t know how much is involved. But given the incentive for national PIGS regulators to have deemed non-performing loans creditworthy so that they can serve as pension collateral, the amounts will be substantial. Having accepted this bad collateral, the national central banks will not be able to reject them for fear of triggering a banking crisis in their own jurisdictions. In addition, they are likely to be forced to accept additional pension guarantees if they are rejected by commercial counterparties and bank failures must be avoided.
The figures concerned are higher than the combined balance sheets of the ECB and the national central banks.
The crisis of rising interest rates in the eurozone will be different from the one facing the US dollar markets. With the eurozone’s systemically important global banks (G-SIBs) with a thirty-fold increase in balance sheet assets to equity, a rise in bond yields of just over a few percent will lead to probably the collapse of the whole euro system, spreading the systemic risk to Japan, where its G-SIBs are oriented in the same way, the United Kingdom and Switzerland, then the United States and China, which have the least operational banking systems.
It will take the big central banks to stage the biggest bailout of the banking system ever, eclipsing the Lehman crisis. The expansion of money and credit required by the network of central banks is unimaginable and comes on top of the massive monetary expansion of the past two years. The collapse of the purchasing power of the entire fiat money system is therefore in prospect, as are the values of everything that depends on it.
Excerpt from “Gold and Silver Prospects for 2022” on Goldmoney.com.
* About the Author: Alasdair Macleod is Research Manager at Goldmoney.
Source: This article was published by the MISES Institute
- 1.The Eurosystem’s balance sheet, i.e. that of the ECB plus those of the national central banks, has fallen from € 4,500bn in December 2019 to € 8,500bn today.
- 2. ICMA European Repo Market Study n ° 38.
- 3.The combined balance sheet of the central bank of the euro system presents “securities held for monetary policy purposes” for a total amount of € 3,694 billion and “liabilities to credit institutions in the euro area linked to monetary policy operations… ”for a total of 3,489 trillion euros at the end of 2020. Repurchase and reverse repurchase agreements are included in these figures, and on the liability side, they represent an increase of 93 % from 2019. This is evidence of increased liquidity support for commercial banks, much of which goes through the repo markets, evidence that outstanding repurchases are considerably higher than at the time of the ICMA survey mentioned above.