Will 'Super Mario' save Europe, the World and thereby rescue Jamaica?

Sunday, September 09, 2012    

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FOR just over one month, the most important central banker in the world has not been Fed Chairman Ben Bernanke, but Italian European Central Bank (ECB) head Mario Draghi, somewhat inevitably dubbed "super Mario" by the international press after the video game of the same name.

On September 6 the waiting ended, as Super Mario, like "helicopter" Ben Bernanke before him, finally crossed the Rubicon — referring appropriately to Julius Ceasar's famous point of no return when he forded the famous Italian river with his army on his way to power — to full quantitative easing with the introduction of a new acronym "outright monetary transactions" or OMR's. The event prompted the German newspaper Die Welt to lead with the headline "Financial Markets cheer the death of the Bundesbank".

In essence, this means that, like the US Federal Reserve and the Bank of England before them, the ECB will now purchase the sovereign bonds of European countries on an as needed, essentially unconstrained, basis to safeguard "appropriate monetary transmission and the singleness of monetary policy". Significantly, "no ex ante quantitative limits are set on the size of outright monetary transactions", making the measure more aggressive than had been expected by the market.

To gain access to this facility, rather like an IMF programme (unsurprisingly, as the IMF will help design the country-specific conditionality and help monitor the programme), a country will need to enter into either a full European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) macroeconomic adjustment programme or a precautionary (Enhanced Credit Conditions Line) programme.

The one real restriction is that "transactions will be focussed on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years".

One of the first impacts, which we have already seen, is the euro rise to almost 1.28 to the US dollar. At first glance, it would seem unusual that the anticipation of what can be loosely called the unlimited printing of money has actually led to a rise rather than a fall in the euro, and a division between what traders (positive) and strategists (negative) believe its impact will be.

What would normally be counterintuitive, meaning that an increase in the supply of euros against the dollar should lead to its fall, is easily understood if one realises investors have effectively been told that they can "front run" the ECB and buy the European debt of the "debt-stressed" countries with the ECB behind them. Unsurprisingly, the debt of both Spain and Italy rallied on the news.

The ECB has taken several other almost equally important steps, advising that it intends by a "legal act" to make it clear that once purchased, its bonds will receive the same treatment as private and other creditors. What this means, in Jamaican terms, is that if, using a purely hypothetical example, our external debt had to be restructured, the IMF and other multilaterals, rather than being a preferred creditor as is current practice, would take the same haircut as other private creditors. This was a key issue in the Greek debt restructuring, where it appeared that there was to be different treatment of "official" governments (particularly the ECB) and other private investors. The problem that this created was that as the amount of European government's official debt increased as a portion of the total debt, the likely recovery value of any debt held by private investors in a debt restructuring decreased, making access to the private capital market more difficult and at increasingly onerous terms.

The next big event internationally is the ruling of the German Constitutional Court on September 12 on the legality of the ESM, and of course the next Federal Open Market Committee meeting on September 12 and 13.

It is likely that the chance of the Fed announcing another round of quantitative easing, or QE3 for short, has increased after Friday's poor jobs report. According to the labour department, the US economy added only 96,000 jobs in August, down from 141,000 in July. Private sector jobs grew 103,000 (the difference reflects a 7,000 decline in public sector jobs), but in the very important manufacturing sector, responsible for much of the recovery, jobs fell by 15,000. Although the unemployment rate ticked down to 8.1% from 8.3%, this was wholly due to 368,000 people dropping out of the labour force, without which the unemployment rate would probably have risen.

Jamaica has been fortunate that the US economy, and particularly the US stock market and consumer confidence, have been somewhat stronger than they looked a few months ago. So far the weakening European economy has not dragged down the US into a feared double dip, which appeared the most likely threat six months ago. The European Central Bank, clearly conscious of the risk of a Lehman 2, this time in Europe, has become extremely proactive, and Germany, however reluctantly, has clearly decided that a European collapse would not be in their interest. In short, the world economy, and consequently Jamaica, may have gained a little time to put their house in order. We all would be wise to take good advantage of this.





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