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The
solvency of the European Central Bank is being called into question by some
brilliant in-depth research from OpenEurope.org.uk. This
independent think tank believes “the EU must now embrace radical reform
based on economic liberalisation, a looser and more
flexible structure, and greater transparency and accountability” in
order for the “EU’s over-loaded institutions, held in low regard
by Europe’s citizens” to meet “the pressing challenges of
weak economic growth, rising global competition, insecurity and a looming
demographic crisis”.
The press
release announcing the report, which is
entitled “A HOUSE BUILT ON SAND? - The ECB
and the hidden cost of saving the euro”, succinctly summarizes several
key points which I quote below. My comments in italics are bracketed:
• “In
parallel with the IMF’s and EU’s multi-billion euro
interventions, the ECB has engaged in its own bail-out operation, providing
cheap credit to insolvent banks and propping up struggling eurozone governments, despite this being against its
own rules. [emphasis added] The ECB is ultimately
underwritten by taxpayers, which means that there is a hidden – and
potentially huge – cost of the eurozone
crisis to taxpayers buried in the ECB’s books.”
• “As
a result, the ECB’s balance sheet is now looking increasingly
vulnerable. We estimate that the ECB has exposure to struggling eurozone economies (the so-called PIIGS) of around
€444bn – an amount roughly equivalent to the GDP of Finland and
Austria combined. Although not all these assets and loans are
‘bad’, many of them could result in serious losses for the ECB
should the eurozone crisis continue to deteriorate. Critically, struggling banks in insolvent
countries have been allowed to shift risky assets away from their own balance
sheets and onto the ECB’s (all the while receiving ECB loans in
return). Many of these assets are extremely difficult to value.” [But
in all likelihood are worth far less than the
carrying value at which they are booked on the ECB’s balance sheet.]
• “Overall,
the ECB is now leveraged around 23 to 24 times, with only €82bn in
capital and reserves…This means that should the ECB see its assets fall
by just 4.25% in value, from booking losses on its loans or purchases of
government debt, its entire capital base would be wiped out.” [The
ECB is over-leveraged just like the sovereign debtors whose interests it is
serving by bailing them out.]
• “Hefty
losses for the ECB are no longer a remote risk, with Greece likely to default
within the next few years [Open Europe is being exceptionally optimistic;
“months” or even “weeks” for a formal default to
occur are real possibilities, but for all practical purposes, Greece has
already defaulted because it does not have the capacity – nor probably
the will – to repay its debts.] – even if it gets a fresh
bail-out package from the EU and IMF – which would also bring down the
country’s banks. We estimate that the ECB has taken on around
€190bn in Greek assets [more than twice the ECB’s capital base]
by propping up the Greek state and banks. Should Greece restructure half of
its debt – which is needed to bring down the country’s debt to
sustainable levels – the ECB is set to face losses of between
€44.5bn and €65.8bn on the government bonds it has purchased and
the collateral it is holding from Greek banks. This is equal to between 2.35%
and 3.47% of assets, meaning it comes close to wiping out the ECB’s
capital base.” [Again, Open Europe is being overly generous by
assuming only one-half of Greece’s debt is restructured. After
all, both halves are equally bad.]
• “A
loss of this magnitude would effectively leave the ECB insolvent and in need
of recapitalisation. It would then have to either
start printing money [The ECB is nothing but a money-printing
organization, so in reality, it would need to print more money than it is
already printing] to cover the losses or ask eurozone
governments to send it more cash (via a capital call to national central
banks). [This capital call could be made in terms of euros,
which the national central banks would need to borrow or print, but it could
also be made in terms of gold, which represents their only real
capital. Whether the national central banks would be willing to
transfer to the ECB some or all of their remaining gold reserves – for
those banks that have any left – remains to be seen.] The
first option would lead to inflation, which is unacceptable in Germany [as
well of course to people throughout the EU], while the second option
amounts to another fully fledged bail-out, with taxpayers facing upfront
costs (rather than loan guarantees as in the government eurozone
bail-outs).”
• “The
ECB’s actions during the financial crisis have not only weighed heavily
on its balance sheet, but also its credibility.” [Its credibility
has already been largely lost. That happened last May when the ECB bent
to the will of politicians ‘solving’ the then brewing Greek
crisis and forced the ECB to break its own rules and buy Greek sovereign
debt. The ECB has continued down this path to ruin by buying the debt
of other over-leveraged sovereigns burdened by their debts.]
For all
practical purposes, the ECB is insolvent. Its doors remain open simply
because it is using the well-worn accounting trickery of all insolvent
banks. Most people cannot recognize when a bank becomes insolvent if it
doesn’t write-down its assets to their real value and reports those
write-downs in its financial accounts. The bank and its directors thus operate
recklessly because the impaired assets are greater than the insolvent
bank’s capital. The insolvency only becomes obvious when the bank
goes out of business, which is a truism made observable by the collapse of
Lehman Brothers. In other words, growing in early 2008 from a few short
sellers and those customers who withdrew their money from Lehman, the market
increasingly recognized that Lehman was insolvent even though its balance
sheet didn’t show it, sending Lehman’s share price into a death
spiral as the awareness of its insolvency grew. This report from Open
Europe is now causing people to look at the ECB’s balance sheet and
available facts, and therefore forcing them to draw conclusions about whether
the ECB is solvent. The implications for anyone holding the euro are as
ominous as those for anyone who owned the shares of Lehman Brothers.
Lest you
come away from reading the above by concluding that the problem is solely
Europe’s, ponder the following.
An article
in this week’s issue of Barron’s about the Open Europe
report says: “The U.S. Federal Reserve sports leverage double the
ECB's, at more than 50 times, but its holdings of U.S. Treasuries are
higher-quality than PIIGS debt.” This comment blithely ignores
the fact that US Treasury debt instruments comprise only 55% of the Federal Reserve’s assets, and much
of the remainder is toxic or illiquid. Further, US Treasury debt is no
more likely to be repaid than that of other over-leveraged sovereigns.
Thus, there
is only one logical conclusion. Given that repayment is
beyond the financial capacity of over-leveraged debtors, much of the debt
overhanging the globe will never be repaid. Because a large portion of
this debt is the principal asset backing national currencies today, these
currencies have been debased. It is debasement just like that
instigated by corrupt and autocratic kings and emperors of yore that we read
about in monetary history, who cheated the citizenry by mixing lead or other
base metals into coins to replace their gold and silver content. But
today the debasement of fiat currency arises from the unrepayable loans of
over-leveraged sovereigns run by corrupt and autocratic bureaucrats and politicians
and of course their hand-maiden, central bankers. This observation succinctly
highlights a theme I have made repeatedly. Central banks are a barbarous relic.
James
Turk
All data and quotes sourced from Reuters. Originally Published by Goldmoney. All rights reserved.
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