In 2017, the ECB should learn to break the rules

This is going to be a crucial year for the European Union. There are more and more voices predicting its disintegration. With the political events that are ahead, it’s not a possibility that should be taken lightly.

If you haven’t already, read George Soros’ article on Project Syndicate about the dangers ahead for Europe. An Eastern European who escaped Hungary in one of its darkest times and built a fortune in the West, Soros has unparalleled insight into the continent’s problems.

The eurozone’s biggest economy, Germany, holds the key to this. Soros points out that the country is not living up to expectations created by its position as the engine of the single currency area, instead trying to impose a straitjacket on other members.

While things are more nuanced than this, it is true that a softening of the German position would help. Unfortunately, this year at least, there is unlikely to be any change in Germany’s attitude. Parliamentary elections are due before October, and Angela Merkel is running again. She is unlikely to say that austerity has failed and propose another course of action, even if she wanted to.

So it’s all back in the hands of the European Central Bank again. Mario Draghi will have to wow the world once again. This time, he really must come true on his 2012 promise that the central bank will do “whatever it takes” to save the euro.

What will it take? Nothing short of tearing up the rulebook and starting again. For the moment, the ECB is buying government bonds in accordance with the capital key — meaning, proportionally with the capital contribution of the eurozone members to its capital. It must change that and do what the Federal Reserve, Bank of England and the Bank of Japan did: buy whatever assets need buying.

Yes, the ECB must start openly helping troubled eurozone members by purchasing their bonds. Italy needs to rescue its banks? The ECB should hoover up Italian government bonds until yields turn negative on any piece of Italian debt, including bank bonds. It could go even further and buy bank bonds direct.

That way, Monte dei Paschi di Siena would be able to issue as many bonds as it needs to cover its capital shortfall, and even deal with the nonperforming loan problem. Remember the Fed’s buying of mortgage-backed securities? For a while, and unnoticed, the Fed became at the time the world’s biggest bad bank.

The Bank of England, in its explanation about how the corporate bond purchases will go, said it will focus on “firms making a material contribution to the UK economy, in order to impart broad economic stimulus.” Surely, the ECB buying Monte dei Paschi’s bonds would impart economic stimulus faster than any other type of monetary policy measure?

Those who know my principles and read this probably believe that I’ve lost my mind. I usually side with the prudent and the savers, not the profligate. However, this is a world in which the ECB finds itself forced to follow rules that other central banks are happy to flout. If it can’t beat them, it should join them.

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