Central Bankers adopt the ostrich position as Ben Bernanke denies any responsibility for Egypt's current crisis

4th February 2011 by Shaun Richards

After discussing the gold price and pointing out that it was something of an enigma at the moment with fundamentals suggesting a rally but technicals suggesting a set back it is interesting to note that there was some real price action yesterday. Just after 4:30 UK time the price shot up by US $20 per ounce and it ended the day having risen  by US $19.20 or 1.44% at US $1352. There were rumours of a large purchase being made but in the gold market there are always rumours! There was also some action in the currency market which I detail below.

The European Central Bank: President Trichet speaks

I pointed out the situation that the ECB currently finds itself in yesterday.

On the one side inflationary trends have raised the Euro zone’s inflation to an above target 2.4% and on the other side are the peripheral Euro zone nations. If it responds to the inflationary trends by raising its interest-rates then the impact on the countries which it is supporting with cheap liquidity will be severe.

This is what Mr.Trichet said in his introductory statement.

Accordingly, the Governing Council will continue to monitor all developments over the period ahead very closely.

This sounds very much like code for what Sir Humphrey Appleby of Yes Minister fame would call “masterly inaction”. I also pointed out that doing nothing would make the ECB look like the Bank of England in some ways. It was nice of Mr.Trichet to echo their language to confirm my suggestion.

Looking ahead to the next few months, inflation rates could temporarily increase further and are likely to stay slightly above 2% for most of 2011, before moderating again around the turn of the year.

So yes the rise is temporary and if we look further forward it will moderate! Sound familiar? If we translate this using the central banker translator it means he is hoping the problem will go away as he is unsure what to do, or if you like the ostrich strategy. Also as I discuss below he may be hoping that the meeting of Euro zone ministers which starts today will offer some sort of strategic solution which in the words of Yes Minister, “although an innovation, it should certainly be tried!” In response the Euro fell about two cents versus the US dollar to 1.36.

Possible Solutions to the problems of the Peripheral Euro zone nations such as Ireland, Greece and Portugal

It is now quite apparent to almost everyone that the so-called rescue schemes for Ireland and Greece are not going very well. As I have pointed out many times providing loans or liquidity does not solve a solvency problem. Indeed I notice that economists in Portugal are pointing out that she should try to avoid the scheme because they feel it will make a bad situation worse. This is not quite the reception that Euro zone politicians expected when they boasted of their “shock and awe” plan back in May 2010! Their taxpayers may quite reasonably wonder why around 205 billion Euros has been advanced (including IMF funds) to achieve at best little effect and at worst a deterioration.

So as this meeting has approached there have been two main suggestions. I reported on one rumoured for Greece on Tuesday of this week where a 35% haircut on her debt, an extension of the loans to a 30 year term and a new loan package would represent an improvement. Frankly this is the first time a debt haircut seems to be close to getting on the table, just under a year late but welcome nonetheless.

In addition there are rumours that the main Euro zone rescue mechanism the European Financial Stability Facility (EFSF) will be expanded and modified. I have written many times that out of its theoretical capacity of 440 billion Euros only half is available in practice so it is too small. The ECB regularly points out that it is unhappy with the way it is having to buy peripheral Euro zone debt under its Securities Markets Programme (SMP). So an expansion of the EFSF combined with allowing it to purchase government bonds seems an obvious solution to your average Eurocrat. To them it has the beneficial side effect of nudging us a little closer to fiscal union as sooner or later if this route is taken the EFSF will issue bonds on behalf of Ireland or Greece. So via the backdoor route of an “emergency” the concept of pan-Euro zone government bonds would start to become a reality.

If we work through this let us look at the case of a ten-year bond Greece issued at just under 99 in April 2010. Due to the problems she has had it closed last night at 73.49. So the EFSF buys it all,cancels the bonds and issues its own more cheaply. Magic, problem solved.

The problems with this “solution”

1. The EFSF is a drain on the creditworthiness of the Euro zone as a whole and in particular relies on Germany. Also Eurostat recently insisted that debt issued by the EFSF should go pro rata into the national accounts of the countries guaranteeing it. So the Euro zones plan to make this like the IMF with its behaviour and debt apparently responsible to nobody has not worked.

2. Past sins often revisit you and back in the banking stress tests of last July banks were in effect encouraged to put such bonds in the section marked hold to maturity as if they did they were outside the stress tests. So having done this banks may refuse to sell and simply wait for their money back at maturity.

3. Should point 2 happen the price will rise and rise as the EFSF tries to buy the bonds back so yet again we will have a false market created by official intervention. The same official intervention that in theory is supposed to stop it!

4. As the ECB is a big holder of such bonds the via it Euro zone taxpayers will be forced to take losses as it has bought quite a few of its bonds at higher prices. So far it is hiding declaring these by operating an accounting system based on the same hold to maturity strategy as discussed above.

So it is by no means a magic solution. And it does nothing at all about the problem that the interest-rate charged by the Euro zone rescue systems such as the EFSF to Ireland and Greece is simply much too high. I will leave the various politicians to sort out the problem that lowering it would increase the chance of success for those taking the whole deal to the German Constitutional Court.

The Chairman of the Federal Reserve Ben Bernanke speaks

The words of the Chairman of the Federal Reserve are usually closely watched and read. As he is now also the largest holder of US government debt having surpassed China’s estimated holding via his policy of asset purchases called QE2 then his words are read even more closely. There was one section in particular which suggested Mr. Bernanke is not for turning and the emphasis is mine.

Even so, with output growth likely to be moderate for a while and with employers reportedly still reluctant to add to their payrolls, it will be several years before the unemployment rate has returned to a more normal level.

Mr. Bernanke also reiterated his view on inflation

overall inflation remains quite low……Core inflation was only 0.7 percent in 2010……. Wage growth has slowed as well

In a reply to a question he disagreed with my view that his policies have indirectly (and maybe directly) contributed to the rise in commodity and food prices which is currently afflicting the world and Egypt in particular. Indeed he said that these countries should do the following.

They can, for example, use monetary policy of their own. They can adjust their exchange rates, which is something that they’ve been reluctant to do in some cases.
If you think about it Ben wants them to revalue their currencies which rather conveniently would achieve one of his objectives which is a lower US dollar! This is a bit much and in addition I think the hubris about being able to easily control inflation is likely to return to haunt him. Also we got this.

equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed, and inflation compensation as measured in the market for inflation-indexed securities has risen from low to more normal levels. Yields on 5- to 10-year Treasury securities initially declined markedly as markets priced in prospective Fed purchases; these yields subsequently rose,

There are several consequences and implications here.In effect he is admitting that rising equity prices are an objective ( The Bernanke Put?) and claiming success, this however does not tally with his implied view that rising commodity prices have nothing to do with his policy. to claim one without admitting the other is inconsistent. Also I spotted this bit which has not been picked up elsewhere “these yields subsequently rose”. When you are the biggest holder of US Treasury Bonds this phrase if we convert it to price falls means that you are taking capital losses and via the size of the holdings the losses must be very large too. Of course officially this is avoiding by simply not marking them to market in another form of the by now rather familiar ostrich strategy. If you ignore a problem by sticking your head in the sand it might go away. In the Peanuts cartoon series was this not the philosophy of Charlie Brown?

Has banking changed at all?

I received a letter from my bank offering me a new credit card yesterday. It offered me no interest-rate on balance transfers for a year. However I notice in the small print that there is an initial charge of 3% for this and interest is charged on the fee. I thought about it and decided that for a bank this had many advantages.

1. It gets the 3% now and as it can fund much more cheaply than this presumably declares a profit.

2. If I transfer debt to it and can pay it receives a high rate of interest of 15.9%.

So at this stage bonuses all round! But if people can’t pay it declares losses and if they are big enough it falls into the arms of the taxpayer! Nice work if you can get it…. It all sounds oddly familiar. Do I need to add that the interest-rate is only 15.4% above the base rate or if I twist the maths a little some 3080% higher!

8 thoughts on “Central Bankers adopt the ostrich position as Ben Bernanke denies any responsibility for Egypt's current crisis”

  1. Shireblogger says:

    Hi SHaun

    Two questions on related matters: 1) am I right in recalling that our Bank of England Asset Purchase Facility Fund Ltd ( QE gilt-holder subsidiary) accounts for its holdings on ‘mark to market’ ( not ‘held to maturity’) and shifts its losses to the Treasury/us 2) Does the practice of BoE and DMO of lending QE gilts to banks via repos etc. defray their costs and/or losses – if so, what are the terms for the gilt-lending which has recently escalated.

    1. Hi Shire
      To answer your questions then the answer to number one is a yes but with the qualification that we only find out the real numbers once a year at the annual report. If they are in the quarterly one then I have missed them……..Here is the one from February 2010.
      “The Company’s financial statements for the period ended 28 February 2010 are given on pages 5–13. Debt securities showed a marked-to-market loss, largely due to a decline in the market value of the Company’s gilt holdings, and £1.8 billion was due from HM Treasury under the Indemnity, leaving a nil profit. Because of the Indemnity and any profit being due to HM Treasury, the Company will never show a profit or a loss.”
      They were looking at a surplus for this year but the rise in yields I have been documenting would have been eroding it.
      2. They will charge for gilt lending. I only have personal experience of equity borrowing where you negotiate with the fund managers holding it a fee or charge….

  2. Ian Jones says:

    Central bankers want inflation shock……. but dont want the plebs to know about it. Govts always cheat, even if they have outsourced it!!!

    1. Drf says:

      Hi Ian, I agree entirely with your statement. So, evidently does Kate Barker, who claims that the BoE is engaged in a confidence trick over UK inflation, as we all well know! If that is true of the BoE it is just as, or even more true, of other Western Central Banks. As you point out, politicians always cheat those who vote for them; that is their modus operandi.

      See http://www.telegraph.co.uk/finance/economics/8304054/Bank-of-England-attempting-inflation-confidence-trick-says-former-MPC-member-Kate-Barker.html

    2. Fletch says:

      Yes, inflation is what they desire despite claiming the opposite.

      Interestingly and uniquely I think the BoE was independent for economic reasons rather than to share blame. I would say over recent years all bad news has been outsourced, how many times do politicians declare it is up to the local government to decide or the Local Health Board or some quango.

  3. Fletch says:


    The break down seems not to be released yet, however we go the available data we have two groups.

    a)Germany, France, etc. with inflation less than 2% over the last year.

    b)Countries near to defaulting who may indeed want a low base rate.

    Can I suggest the French-man doesn’t think inflation is temporarily rather than nonexistent?

    1. Hi Fletch
      The preliminary or flash figures do not come with a national breakdown. However in the December figures German CPI inflation had risen to 1.9% so with a further general pickup it will be interesting to see if Germany was part of it.

      As to Mr.Trichet I think he lost his equilibrium a bit at the January meeting. It was his own fault because he had previously boasted about the Euro zones inflation performance having been virtually exactly in line with the ECB’s mandate since the ECB began and that German inflation was only 1.5%! He must have known there were dangers of a rise but shot from the hip in December and therefore felt the need to emphasise his inflationary credentials in January…As he approaches the end of his tenure he may well be thinkimng that with any luck he can pass this problem to his successor.

      1. Fletch says:

        I was looking at Eurostat figures that seem to give the break down for December to December, as well the 2.4% for January to January.

        Maybe Trichet will declare his legacy as the period of low inflation(which I assume he will in the future declare as his main mandate) rather than the economic mess.
        I am sure there is something from yes minister in declaring success whilst you can.

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