Marshall Auerback: All Roads Lead to the ECB

Posted on by

By Marshall Auerback, a hedge fund manager and portfolio strategist. Cross posted from New Economic Perspectives

We’ve always been a fan of Professor Paul De Grauwe from University of Leuven, who has consistently pointed out the structural flaws inherent in the original structures of the EU. Recently, Professor de Grauwe wrote an excellent analysis explaining why the latest “rescue plan” cobbled together by the Eurozone authorities is destined to fail.

The key points:

1) ECB is not currently a ‘lender of last resort’. The ECB was set up with fundamental flaws, where “… one of the ECB’s main concerns is the defense of its balance sheet quality. That is, a concern about avoiding losses and showing positive equity- even if that leads to financial instability.” This is a profoundly misconceived idea. As we have noted many times, a private bank needs capital – clearly because there are prudential regulations requiring that – but because it can become insolvent. It has not currency-issuing capacity in its own right. While the ECB has an elaborate formula for determining how capital is from the national member banks at an intrinsic level, it has no need for capital. It could operate forever with a balance sheet that if held by a private bank would signal insolvency. There are no comparable concepts for a currency issuer and a currency user in terms of solvency. The latter is always at risk of insolvency the former never, so the ECB’s focus on profitability is not only misguided, but leading to inadequate policy responses.

2) The creation of the European Financial Stability Facility (EFSF) and the ESM has been motivated by the overriding concern of the ECB to protect its balance sheet and to avoid engaging in “fiscal policy”. The problem again goes back to the creation of the euro: no supranational fiscal authority to go with a supranational central bank, which means that the only entity that can conceivably carry out “fiscal transfers” of the sort exemplified by a bond buying operation is the ECB. Sure, the actual fiscal transfers can be ’subcontracted” to the EFSF and ultimately the ESM, but it can only work if the latter’s balance sheet is linked to the ECB’s, giving it the same unlimited capacity to buy up the bonds and thereby deal with the insolvency issue. As things stand now, per de Grauwe: “The enlarged responsibilities that are now given to the ESM are to be seen as a cover-up of the failure of the ECB to take up its responsibility of the guardian of financial stability in the Eurozone; a responsibility that only the ECB can fulfill”.

3) Related to this problem is the fact that the ESM has been given only finite resources as per Germany’s stipulation the minute it begins. It is capitalised at 500bn euros. And it’s unclear that Germany can go much further, given that there are currently 3 constitutional challenges which the ESM is now facing within Germany’s courts. This will delay ratification of the vote taken last week by Germany’s parliament to ratify the ESM’s existence, as well as limiting its firepower going forward. The ESM’s “bazooka” is in effect a pop-gun. Consequently, as de Grauwe argues, “Investors will start forecasting the moment when the ESM will run out of cash. They will then do what one expects from clever people. They will sell bonds now rather than later.”

As is clear from every FX crisis in the past, “A central bank that pegs the exchange rate and has a finite stock of international reserves to defend its currency against speculative attacks faces the same problem. At some point, the stock of reserves is depleted and the central bank has to stop defending the currency. Speculators do not wait for that moment to happen. They set in motion their speculative sales of the currency much before the moment of depletion, triggering a self-fulfilling crisis. “

Until Europe’s authorities have this figured out, the crisis will continue. All roads lead back to the ECB.

Print Friendly, PDF & Email


  1. Paul Blumenthal

    Current system is fascism. That’s true. But true free market economy always finishes as fascism (corporationism). That’s something that you guys don’t see. Let me give you an example:

    It is 1998. Nobody heard of web search, right? I don’t think that the term was even defined. So, obviously as nobody knew what it was, there was no Government regulation or intervention in the web search market, right? So, we have 1998 and we have 2 guys in a Garage creating Google. And thanks to the lack of regulation and lack of the Government intervention Google works out beautifully. So far so good. We have 100% pure beautiful capitalism for Google. Everybody happy. Capitalism at its finest. Now comes the part that is explained by Marx and you guys simply don’t grasp: In the year of 2010 Google sponsors a bill to regulate the market economy so its position as a monopoly for web search is secured by the law. That’s the fact bill like this has been developed by Google. Now Google bribes (aka ‘lobbies’) the House/Senate/etc and gets what it wants: if you use Google connections goes through fat and fast Internet connection. If you use something else, no matter how many times better, the law says that slower connections must be used. That’s exactly right. That’s fascism: laws created by corporations to secure their monopolistic positions at the same time empowering Government more as now it needs to eavesdrop only Google’s traffic. Everybody wins. Except for constituency that is. Fascism. In other words once those corporations grow big enough thanks to the lack of regulation and free markets THEY will regulate instead of the Government (democratically elected Government I should add).

    And I know what will you say: “Ahh.. it’s still because of the GOvernment because the Government enables this. Because the GOvernment allows bribing and lobbying to happen”.
    Well, this argument is aking to communists argumentation that communism would work great if just people could understand that they ought to be equal and not want more than their neighbor. It is the same stupid logic: oh capitalism would work great only if these stupid people would understand not to take bribes, lobby and have no special interests. It is utopia my friends. Politicians will always accept fact checks from corporations. This way corporations ultimately destroy capitalism that created them and replace it with corporationism known also as fascism. That’s the path that not only Google took, but also banks in the past – hence FED was created to secure their interests in 1917. Big Pharma, hence MedicAid and Medicare were created. And military complex hence all the wars.

    You see capitalism is self-destructing. So go there and read Marx before dismissing him as an idiot.

    Paul Blumenthal, Founder.

    1. J.

      > In the year of 2010 Google sponsors a bill to regulate the market economy so its position as a monopoly for web search is secured by the law. That’s the fact bill like this has been developed by Google.

      Um. Are you sure that’s the fact? Please post a link to this bill.

      You could try searching for this bill on Yahoo, or maybe Bing

        1. K Ackermann

          Google has been fairly tight-lipped about that project, saying the results are not meant for human consumtion.

        2. K Ackermann

          George Dyson, writing about Google in an essay titled Turing’s Cathedral:

          “When I was there, just before the IPO, I thought the coziness to be almost overwhelming. Happy Golden Retrievers running in slow motion through water sprinklers on the lawn. People waving and smiling, toys everywhere. I immediately suspected that unimaginable evil was happening somewhere in the dark corners. If the devil would come to earth, what place would be better to hide?”

          1. Ruben

            The most interesting part of the essay was when Tyson told that somebody at Google explained that they are not scanning all books to be read by people, but rather, to be read by an artificial intelligence.

            I connect this with another piece I read about Google’s ambition to develop something beyond a search algorithm: an algorithm that could actually answer questions.

            It would be nice if this algorithm could answer the questions : what do we do to solve the European Sovereign debt crisis? What optimization rules and what constraints for the ECB? What size of banks? How many banks? Which banks? Banks?

            No need for regulators, no need for free markets, no need for democracy. A few fixes now and then. Some updating of numerical algoriths. Regular updating of databases.

          2. reslez

            what do we do to solve the European Sovereign debt crisis? What optimization rules and what constraints for the ECB? What size of banks? How many banks? Which banks? Banks?

            Such an AI would be doomed. Those in power don’t want these problems solved.

    2. Andrew

      I think Paul has got the jist of the issue. I assumed he was giving some scenarios of what could go wrong, rather than facts.

      Unless I’m reading between the lines where I shouldn’t.

      1. K Ackermann

        He’s got the power structure about right, but I think it fits better under plutocracy. Fascism, I think, requires a stronger element of consent.

        The passive consent we have (here in the US) comes primarily from people with their head in the sand.

  2. Schofield

    Well you are right the system economic and political always inclines to Fascism. That’s because human beings are schizophrenic they struggle to balance the best way to secure their self-interest either through selfish action or cooperative/collective action with others. As the anthropologist Christopher Boehm says in his book “Hierarchy in the Forest” human beings love to dominate but hate being dominated. China is a good example of Facist Capitalism or Vampire Capitalism that sucks the life-blood out others hampering them in their quest for well-being. Party bosses and their families take huge bribes and exploit their positions wherever they can. It is debatable which country is more corrupt, the United States or China. All that responsible human beings can do is recognise the schizophrenia and erect checks and balances more carefully than societies have done in the past to get to some semblance of Responsible Capitalism and Democracy.

    1. LeonovaBalletRusse

      S, leadership without dominance is the only really feasible model in C.21.

    2. Jim

      What about the corrupt nature of the Eurozone, which has explicilty attempted to thwart democracy at every turn. Compared to the EZ, the US is a paragon of virtue. As I type this, the unelected Eurocrats in Brussels are attempting to subvert German democracy by making Germany an economic backstop to the entire ill-fated construct known as the Eurozone.

      Many progressives have no problem with this, as they consider it a price necessary to ensure the “collective good” – the Eurozone. German voter opposition? Many progressive claim that Germans simply don’t know what’s good for them.

      1. Kraken

        I’d agree with Jim. The lender of last resort is all well and good, but where is the money going and who benefits from the ECB buying all the bonds. It seems as if, like the USA, the beneficiaries are insolvent, over leveraged banks,and bondholders, that continue to game the rigged system. How is this going to lead to downsizing and restructuring the financial goliath, and get money into the hands of the people that need to work and live? As per Hugh, everything must be looked at in terms of sustaining the kleptocracy at the expense of the common man. Somehow the system must be broken apart and reset.

  3. LeonovaBalletRusse

    Re EU: Epic Fail from the start: true purpose was control of .01% Top Dogs via:

    effective .01% Old Guard monopoly control over deep ultraconservative process at the heart of the system (fiscally ultraconservative Holy Roman Reich III+=>IV, assured by placement of “heart” of the system in Brussels);

    unrealistic guaranteed FIX on “inflation” ceiling and velocity in perpetuity (a static goal incompatible with spontaneous evolution of the system, in which “known unknowns” were not accounted for, and “unknown unkowns” could not be accounted for);

    unrealistic guaranteed FIX on “stability” boundaries based on fear of recurrence of past politically-driven economic disasters;

    effective substitution of Euro for D-mark, with denial that this was so;

    romantic belief that the principals would crack the NUT of “political union” by enacting comprehensive fiscal union in time to save the system in the future, even if this meant that the principals would incur painful financial loss;

    romantic belief that “the worst-case-scenario” could never happen.

    The question is: can there be a newly-defined “United States of Europe” led by France, with common moral/political praxis and common currency, that would let Germany off the hook; and which would open the door to trade and currency exchanges with countries formerly responsive to French 18th century “enlightenment” values toward complex modernity, including the Russia of St. Petersburg, and former Eastern Bloc countries? Might also a New Celtic Europe find its place within this C21 United States of Europe a l’americaine? of Lafayette’s imagination? a “dynamic” spontaneous New European bloc?

    1. LeonovaBalletRusse

      As for fear of “Deutscheland Uber Alles,” let’s get real. The Marshall Plan is still in effect in Germany in some form or other, and the U.S. Armed Forces/Hospital presence in Germany is not likely to go away.

      “Balance of power” still is key to the code of order.

      1. Jim

        So, what are you saying? That the German voter does not have control of his own country?

        That the entire Eurozone is a procterate of the US of A, and will do whatever the current president dictates?

        1. LeonovaBalletRusse

          Jim, no, I’m not saying that. I’m saying it seems that the U.S. “check” presence on German soil should serve to make “the others” less anxious. “NATO” stabilizer.

        2. Fiver

          Will the EZ do whatever the President says? No.

          What Wall Street and London banks say to do? Yes.

  4. BagHolder

    Another nonsense article.

    The lender of last resort is to provide lending when there is a temporary liquidity crisis. We don’t have that.

    What should be done is:

    Mark things to market
    Temporarily nationalize insolvent banks
    Haircut/wipeout the bondholders/shareholders
    Form new banks where necessary
    Get on with life

    1. joebhed

      Yeah, that has to be done, too.
      Eventually there is no way out without the big reckoning of accounts that were fractured by financialism.
      All of that virtual wealth will disappear.

      But the deeper issue remains one of prevention – along with getting on with our lives.
      It is just as important to prevent the future crisis as it is to recover from this one – when its over.

      We need to have a monetary system that is not dependent on banks making loans in order to have a money supply to provide exchange in the national economy.

      Cong. Dennis Kucinich’s NEED Act, H.R. 2990, proposes to end the private creation of the nation’s money and to put the monetary system of the country under the guidance of a public money administration.

      The same question exists even WHEN the ECB becomes the bankers’ banker. Ar they going to save the financialists and the bankers, or are they going to save the national economies of the EMU member countries?

    2. Andrew

      So it all starts over and the same thing happens again.

      You improved things a bit by bringing back moral hazard, but the system is still broken.

    3. They didn't leave me a choice

      Does your solution include a wholesale bailout of the public? If it doesn’t, it’s a pretty lousy and short-lived a solution…

  5. BagHolder

    >The creation of the European Financial Stability Facility
    > (EFSF) and the ESM has been motivated by the overriding
    >concern of the ECB to protect its balance sheet and to avoid
    >engaging in “fiscal policy”.

    False. The overriding concern for the creation of these vehicles has been concealing losses in order to keep the current establishment (government and corporatocracy) in power.

      1. Courant

        BagHolder + Kraken
        Seems to me that both are not necessarily mutually exclusive. They are just different order of objectives (aka operational/ strategic or intermediate/ultimate objectives)

  6. Hugh

    I agree with others here. Both De Grauwe and Auerback are advocating using MMT principles selectively to prop up the current financial system. That system is undemocratic, predatory, and kleptocratic. Why should any of us support such a project?

    1. Andrew

      MMT is useful to accurately diagnose the patient. As MMT places greater emphasis on validating theories with empircal data, they should (and mostly do) agree on the illness. There are a few different prescriptions that would work but it’s a political choice to a large extent.

      If for example they prescribed to nationalise the banks and have a debt jubilee, others would bang on about heading for the gulags.

      You can read Bill Mitchell on MMT for a different (more left wing) perspective.

      1. enouf

        This is just my humble opinion, but;
        What a bunch of Horsesh**!

        Using terms like “validate” and “empirical data” made me laugh so friggin hard, i fell off my chair… Thank you for the awesome chuckle (but i think i hurt my hip :-p)


  7. gerold k.b. weber

    Thx to Marshall Auerback for his piece which adds value to De Grauwe’s excellent analysis.

    As a citizen of an Eurozone country with some contact to banking, banking regulation and central banking it seems to me that De Grauwe’s and your analysis is right on the mark, and we (the Eurozone) certainly should not fight the ‘Great Financial Crisis’ with hands tied behind our backs. Let us hope there is a way to untie the knots step by step.

    Although, the currently existing Eurozone money creation restrictions to plug holes in balance sheets of financial institutions and sovereigns should bring into focus some questions which are seldom asked and discussed:

    Who are the wealthy and superrich owners of the financial assets which correspond to all that holes? And would they be collectively (as a class) or individually be prepared to contribute to overcome the crisis?

    We have to sharpen the discourse to make clear that we as a society have political-econonomic options to handle all that debt.

  8. The Dork of Cork

    I don’t get it.
    Central banks even the ECB can’t produce unbacked fiat.
    They must hold Gold or something on the other side.

    Auerback & De Grauwe are great analysts but they want the Euro to work for some reason.
    If the Euro boys get their way we are all dead as they see us as Collateral and not as sentient human beings.

    Goverments must produce fiat independent of Central banks if they are to assume any real political power over and above the men behind the curtain.
    A talley stick system is best as it will crush the goldsmiths but a small country cannot do this as the bankers would merely whisper in a bigger countries ear and use that country as a agent for their own dark ends as they always have.
    The Best that Ireland and Greece can do is print punts or Drachmas so as to reduce the devastating banking leverage withen their system – we can therefore reduce the money exports to these sick twisted bastards ….even if it kills us.

    We must hope someone somewhere someday in a great country would truely crush the bankers by making leverage itself redundent via a true debt free system without any leverage to speak of.
    Europe needs those Great Norman Kings back again.

    1. F. Beard

      They must hold Gold or something on the other side. The Dork of Cork

      All they need on the other (asset) side is a promise to repay the loan. Or the central bank could buy assets and even overpay for them to get money into the economy.

  9. The Dork of Cork

    @F Beard.
    But does not a central bank merely hold existing money expressed as debt ?
    Where is the new money ?
    New Euros however need Gold on the other side.
    Is that really new Money ?

    I don’t know really.
    There are times when I could not give a toss.

    1. F. Beard

      Central banks lend or spend (Open Market Purchases) new money into existence. That’s where new money comes from under the current system.

    1. F. Beard

      It spends like real money and one can even pay Federal taxes with it so I’d say IT IS real money.

  10. The Dork of Cork

    But it has a yield over 1.00
    Thats not money.
    That is a loan.
    This is money

    1. F. Beard

      The debt of a monetary sovereign is ITSELF a form of money and worse, one that pays interest.

      But yea, the US government should simply spend its money into existence without any borrowing.

      As for a universal bailout, it should be funded with US Notes so the banks will be forced to take them.

  11. Fiver

    Ah, another top drawer elite LSE/Fed dispenser of wisdom tells us Germany must step up, drop its collective drawers, and smile while God’s Will, executed via adored Anglosphere’s particle money, which sometimes exists, and sometimes not, is loaded into the ECB’s printers.

    Meanwhile, over at the real problem (check out the other charts as well)

    There’s no sign of anything resembling a sound financial system at all.

    And if you read the little blurb by the author of this piece as contribution to the document “After the Crisis: Towards a Sustainable Growth Model”, you’ll find his notion of “reform” – note there remains a total disconnect with the reality depicted in the linked charts. The dog up the tree in Europe cannot be earthed unless that relentless tossing of steaks ceases.

  12. Eric

    Mr. Aurback does not mention the main issue: the no bailout clause of the Lisbon treaty. Call it a flaw or whatever you want it to call, but the fact of the matter is that the people in the Northern economies only signed up to the euro because it was agreed by treaty that eurozone governments would never be bailed out, so no fiscal transfers in any form or shape.
    Whatever you may think of it, this was a political choice, and I do not envisage the voters in the Northern countries will change their opinion on this.
    All initiatives to save the periphery will hit this barrier, it’s futile to discuss any changes to the ECB that would mean the taxpayers in the Northern countries become liable to debts of other countries.
    If the current actions of ECB or ESM are not sufficient, I think some countries will go bankrupt and have no choice other than to leave the euro.

  13. Kunst

    Let’s play a game. It doesn’t matter too much what game it is. There will be winners and losers, even if we’re just flipping coins. Now let the winners use their winnings to change the rules of the game to their advantage. Winners win more, losers lose more. Repeat until…

Comments are closed.