Markets are in rally mode due to the latest plan voiced by European Central Bank (ECB) President Draghi. Here is that plan: the ECB will have an open check book for the purpose of purchasing an unlimited amount of government bonds so long as that euro zone government complies with an economic reform program approved by the euro zone leaders. The ECB, in turn, will “sterilize” those purchases. Meaning it will offset the purchases by taking an equal amount of money out of circulation. In this way it will keep its mandate to maintain stable prices.
The ECB had previously inserted itself as the lender of last resort for European banks. With this new plan, the ECB is now effectively the lender of last resort for government bonds. This is huge. What the new plan doesn’t do, however, is help with some structural areas that were identified in the BusinessInsider article that we linked to this morning. As stated in the article:
It doesn’t address the core flaws with the Eurozone’s architecture relating to competitiveness or the fact that governments can still have a run on their debt. That needs to be addressed via fiscal union, banking union, and so forth. All of those are political projects that will take a long time.
But something to bear in mind is that the US banking crisis was going on for a long time and it didn’t end until the entities with unlimited money (The Fed and the Treasury) stepped up in a big way. Prior the crisis being over, the US tried a lot of half-measures (remember the super-SIV?) that didn’t do anything, an which sounded a lot like what they’ve tried in Europe. So it’s understandable that people are excited about the prospect of a real move by the ECB.
This latest move is a sign that the financial bazookas are going to be deployed. And as we’ve been saying now for quite some time, it wouldn’t be prudent to bet against the use of the financial bazookas that will at least temporarily goose financial markets higher. Whether this works over the long-term is debatable…but you’d better have at least some risk-on for the short term.