Eurobonds through the Backdoor

Published on 2012/09/10

Share prices are climbing to historic all-time highs because the ECB announced that it would buy bonds in unlimited amounts. As good as these tidings may seem, the long-term ramifications will be dramatic and no reason to rejoice at all. Quite on the contrary. For this is what the decision factually implies:

  1. The path for a Eurozone transfer union has officially and definitively been cleared. Whatever ruling Germany’s Constitutional Court of Justice might hand down is completely irrelevant because the collectivisation of debt will be enforced by the ECB no matter what. As it were, Eurobonds are being introduced through the backdoor. The euro will be saved “at any cost” – which hardly qualifies as good news.
  2. The parliaments in Europe have been virtually stripped of their power because they will lose their budgetary authority. From here on out, the ECB will govern Europe.
  3. The ECB is about to gamble away the only and quintessential asset that a central bank has, namely the public’s trust in its ability and willingness to pursue an independent policy solely committed to the preservation of monetary stability.
  4. In the future, the interest rates paid for government bonds in Europe will no longer be set by the market, but be dictated by policy makers. As it is, no one can say anymore how high the interest on Italian or Spanish bonds would actually be without the ECB purchases.
  5. Even if the figures now on the table imply no increase in inflation yet, the government bond purchases are bound to accelerate the inflation rate in the medium and long run.

Europe is heading down a treacherous road. Unlike the United States, we are anyway plagued by structural problems caused by a negative demographic trend and an unaffordable welfare state. Although the exchange rate of the euro has recently rallied, I believe that the United States, and with it the US dollar, will outperform the Eurozone in the long run. This is not to say that the US is without its own bag of troubles. But one thing the United States is not up against are the ramifications of a half-baked single-currency. And one thing it has going in its favour is the nation’s positive demographic growth. Moreover, the welfare mentality is less pronounced than it is, say, in Germany, where virtually the entire spectrum of political parties pursues a social-democrat agenda.

If Europe was to descend into a serious crisis, however, this would not leave the United States unscathed. Accordingly, Americans are monitoring developments in Europe with plausible concern.

What Americans and Europeans have in common, though, is a reckless borrowing policy. The extremely low interest rates to be paid on bonds in countries like Germany, the United States or Japan reflect the true debt level no more than the substantially higher interest rates on bonds of so-called emerging markets do, though these are often less indebted.

Those of us with a long-term perspective will therefore want to invest some of their money in the US dollar zone and in bonds from emerging countries. And of course in real estate, always bearing in mind that it is always a good idea to spread your risk internationally, e.g. through commitments in the United States. In addition, bullion recommends itself as the ultimate insurance policy against the big financial crash that the ECB has done nothing to avert but will merely delay with its decision.

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