Mario Draghi Urges “War-like” Flood Of Debt As ECB Considers Launching Helicopter Money

In retrospect, Mario Draghi will be remembered as the central banker who was always willing to go the extra mile to backstop the historic asset bubble that the ECB inflated since he replaced Jean-Claude Trichet in 2011, making the European Central Bank the biggest hedge fund in the world with more than $5 trillion in assets assets.

As shown below, since his arrived, the ECB’s balance sheet more than doubled from €2 trillion to above €4.5 trillion by Draghi’s departure in Oct 2019.

But if one asks Draghi, the man who once famously declared he would do “whatever it takes” (a phrase that has since been so overused by central banking peers it no longer has any impact) to keep the Eurozone (and Euro) intact, if he would do anything different, he would likely say he didn’t do enough… which is why Draghi was never all that popular in the notoriously austere Germany which remembers very well what happens when one prints money with reckless abandon in hopes of “fixing” things. Incidentally, Draghi’s critics will also say that the former ECB head rushed into every crisis, no matter how severe even if it was a modest 5% drop in the Stoxx 600, ready and willing to print more money, and he did just that so often.

Which is why with Europe now facing a truly existential crisis, its economy on the verge of a depression and total shutdown due to coronavirus lockdowns, there are those who say there is nothing in the ECB’s arsenal that has any real potency left, and is also why last week’s announcement of the Pandemic Emergency Purchase Programme barely registered in risk asset prices.

So with Europe desperate to truly shock and awe, where does it go to? Why to Draghi’s arsenal of course, and specifically what Bloomberg dubbed is “its most powerful” bond buying tool, one which was never tested even at the depths of the financial crisis.

We are talking about the infamous OMT, also known as Outright Monetary Transactions.

According to Bloomberg, while the OMT was briefly mentioned at last week’s emergency meeting of the Governing Council, which focused on agreeing a different purchase program, the far more modest Pandemic Emergency Purchase Programme which has “only” €750BN in firepower, “it is clear there would be broad support”, Bloomberg’s sources said (although that may be yet another trial balloon to preemptively test Germany’s resistance to an ECB facility that could in theory inject unlimited liquidity into the system.

Activating OMT – which is contingent on countries securing from a European bailout fund – would benefit euro-area members whose strained public finances risk limiting their ability to cushion the blow of the coronavirus pandemic. Greek bonds rallied after the report, with the yield on 10-year securities falling 11 basis points to 2.35%.

The OMT was designed in the late summer of 2012 after Draghi pledged to do “whatever it takes” to save the euro during the region’s debt crisis. It allows the ECB to buy nearly unlimited quantities of a nation’s sovereign debt, pushing down bond yields that risk making much-needed fiscal stimulus unaffordable.

Unlike the rest of the ECB’s facilities, the OMT – which was challenged in German court – was never used, as a result of stern pushback from Germany’s Bundesbank, which was worried it would breach EU law against monetary financing of governments. Such worries appear trivial now that Europe – and even Germany – is seeking to issue trillions in debt to bridge the current shutdown of its economy. And since someone has to buy all that newly issued debt, the most likely buyer is none other than the ECB as yet another continent joins the helicopter money race.

And indeed, as Bloomberg tongue in cheek notes, “due to the nature of the current shock though, officials no longer expect the Bundesbank to be strongly opposed.“

The OMT, which is basically a wholesale adoption of helicopter money and assures that going forward the ECB would monetize most if not all European debt, is being discussed at a time when the Euro Area is struggling to find the right way forward in funding its impacted member states. One such approach is using credit lines backstopped by the European Stability Mechanism, a step Governing Council member Francois Villeroy de Galhau has already urged them to take. But that form of assistance “requires governments to sign up to reforms, a stigma that could deter some” Bloomberg notes, and by some it means those governments that never actually pursued any real reforms. As such, European governments are currently considering how they might provide credit lines with limited or no conditionality.

The central bank maintains that any EU decision on ESM credit lines shouldn’t explicitly state that OMT could follow, one person said. That judgment would be made by the ECB as an independent central bank.

Meanwhile, Italy, which has been hardest-hit by the pandemic and which as always is most in need of unlimited, no-strings-attached funding, has predictably argued that credit lines can only be a temporary solution. The country has the euro zone’s second-highest debt burden after Greece, making higher yields especially hard to cope with. The nation’s annual refinancing needs on public debt already amount to 20% of GDP.

Instead, Italy has been pushing for an alternative solution, namely the Euro-wide coronabond, which would be backstopped by all member states. Read Germany, which is also why Germany has been vocally against this route as otherwise German taxpayers could riot. As Bloomberg adds, during a teleconference of euro-area finance ministers last night, Lagarde made a strong push for that kind of joint debt issuance, though it fell short of garnering sufficient support with Germany refusing to even consider the option.

This is where the OMT comes in, because being an “emergency tool”, it would bypass all the traditional bickering Europe is so known for and allow the ECB to monetize pretty much anything; furthermore if the OMT is activated, it would not be bound by the limits of existing bond-buying operations, which require buying debt in proportion to the size of individual economies. In an analysis of how long the ECB can buy bonds under its existing framework before it runs out of eligible bonds, Bank of America found that “as is” the ECB has space until September at best (and likely sooner) before it is limited by structural considerations.

That said, even the OMT is subject to limits on how much of each government’s bonds the ECB can hold, though policy makers have already said they’re willing to consider raising those limits. Purchases would be made in the secondary market.

* * *

And speaking of the tsunami of debt that is coming Europe’s way, late on Wednesday, perhaps realizing that his star is shining again and it may be time to come out of retirement, Mario Draghi penned an FT oped titled “We face a war against coronavirus and must mobilise accordingly”, and in which – predictably makes the case for a lot more debt. In fact, a deluge of debt: “it is already clear that the answer must involve a significant increase in public debt. The loss of income incurred by the private sector — and any debt raised to fill the gap — must eventually be absorbed, wholly or in part, on to government balance sheets. Much higher public debt levels will become a permanent feature of our economies and will be accompanied by private debt cancellation.”

Of course, even Draghi realizes that what he advocates is unleashing a tidal wave of debt in a continent already drowning in it (and where the cause of every recent crisis is precisely the record amount of debt). However, to Draghi that makes no different, and as he says:

Either governments compensate borrowers for their expenses, or those borrowers will fail and the guarantee will be made good by the government. If moral hazard can be contained, the former is better for the economy. The second route is likely to be less costly for the budget. Both cases will lead to governments absorbing a large share of the income loss caused by the shutdown, if jobs and capacity are to be protected.

Public debt levels will have increased. But the alternative — a permanent destruction of productive capacity and therefore of the fiscal base — would be much more damaging to the economy and eventually to government credit. We must also remember that given the present and probable future levels of interest rates, such an increase in government debt will not add to its servicing costs.

Of course, the question here is whether moral hazard can be contained, and as the past month has shown, it can’t because now virtually every company demands a bailout. And should the ECB follow the Fed in backstopping everything, it will only ensure that Moral Hazard is a de facto standard of life in perpetuity. As for Draghi’s assumption that present and future levels of interest rates are too low, we have already seen a surge in bund yields following Germany’s surrender to the forces of fiscal spending. We can only wonder how high they will reach once Europe bends over to Draghi’s latest idea and unleashes virtually infinite debt. And since at much higher rates only a price indescriminate buyer will purchase European debt, it also answers our question of who will be forced to fund Europe’s deficit going forward. The answer: the ECB.

And just like that, Europe is now en route to joining the helicopter money parade, as one nation after another starts the countdown to the final destruction of fiat currency. No wonder nobody can find any physical gold, anywhere.

Draghi’s full op-ed is below (FT link here).

We face a war against coronavirus and must mobilise accordingly

Higher public debt levels will become an economic feature and be accompanied by private debt cancellation

The coronavirus pandemic is a human tragedy of potentially biblical proportions. Many today are living in fear of their lives or mourning their loved ones. The actions being taken by governments to prevent our health systems from being overwhelmed are brave and necessary. They must be supported.

But those actions also come with a huge and unavoidable economic cost. While many face a loss of life, a great many more face a loss of livelihood. Day by day, the economic news is worsening. Companies face a loss of income across the whole economy. A great many are already downsizing and laying off workers. A deep recession is inevitable.

The challenge we face is how to act with sufficient strength and speed to prevent the recession from morphing into a prolonged depression, made deeper by a plethora of defaults leaving irreversible damage. It is already clear that the answer must involve a significant increase in public debt. The loss of income incurred by the private sector — and any debt raised to fill the gap — must eventually be absorbed, wholly or in part, on to government balance sheets. Much higher public debt levels will become a permanent feature of our economies and will be accompanied by private debt cancellation.

It is the proper role of the state to deploy its balance sheet to protect citizens and the economy against shocks that the private sector is not responsible for and cannot absorb. States have always done so in the face of national emergencies. Wars — the most relevant precedent — were financed by increases in public debt. During the first world war, in Italy and Germany between 6 and 15 per cent of war spending in real terms was financed from taxes. In Austria-Hungary, Russia and France, none of the continuing costs of the war were paid out of taxes. Everywhere, the tax base was eroded by war damage and conscription. Today, it is by the pandemic’s human distress and the shutdown.

The key question is not whether but how the state should put its balance sheet to good use. The priority must not only be providing basic income for those who lose their jobs. We must protect people from losing their jobs in the first place. If we do not, we will emerge from this crisis with permanently lower employment and capacity, as families and companies struggle to repair their balance sheets and rebuild net assets.

Employment and unemployment subsidies and the postponement of taxes are important steps that have already been introduced by many governments. But protecting employment and productive capacity at a time of dramatic income loss requires immediate liquidity support. This is essential for all businesses to cover their operating expenses during the crisis, be they large corporations or even more so small and medium-sized enterprises and self-employed entrepreneurs. Several governments have already introduced welcome measures to channel liquidity to struggling businesses. But a more comprehensive approach is needed.

While different European countries have varying financial and industrial structures, the only effective way to reach immediately into every crack of the economy is to fully mobilise their entire financial systems: bond markets, mostly for large corporates, banking systems and in some countries even the postal system for everybody else. And it has to be done immediately, avoiding bureaucratic delays. Banks in particular extend across the entire economy and can create money instantly by allowing overdrafts or opening credit facilities.

Banks must rapidly lend funds at zero cost to companies prepared to save jobs. Since in this way they are becoming a vehicle for public policy, the capital they need to perform this task must be provided by the government in the form of state guarantees on all additional overdrafts or loans. Neither regulation nor collateral rules should stand in the way of creating all the space needed in bank balance sheets for this purpose. Furthermore, the cost of these guarantees should not be based on the credit risk of the company that receives them, but should be zero regardless of the cost of funding of the government that issues them.

Companies, however, will not draw on liquidity support simply because credit is cheap. In some cases, for example businesses with an order backlog, their losses may be recoverable and then they will repay debt. In other sectors, this will probably not be the case.

Such companies may still be able to absorb this crisis for a short period of time and raise debt to keep their staff in work. But their accumulated losses risk impairing their ability to invest afterwards. And, were the virus outbreak and associated lockdowns to last, they could realistically remain in business only if the debt raised to keep people employed during that time were eventually cancelled.

Either governments compensate borrowers for their expenses, or those borrowers will fail and the guarantee will be made good by the government. If moral hazard can be contained, the former is better for the economy. The second route is likely to be less costly for the budget. Both cases will lead to governments absorbing a large share of the income loss caused by the shutdown, if jobs and capacity are to be protected.

Public debt levels will have increased. But the alternative — a permanent destruction of productive capacity and therefore of the fiscal base — would be much more damaging to the economy and eventually to government credit. We must also remember that given the present and probable future levels of interest rates, such an increase in government debt will not add to its servicing costs.

In some respects, Europe is well equipped to deal with this extraordinary shock. It has a granular financial structure able to channel funds to every part of the economy that needs it. It has a strong public sector able to co-ordinate a rapid policy response. Speed is absolutely essential for effectiveness.

Faced with unforeseen circumstances, a change of mindset is as necessary in this crisis as it would be in times of war. The shock we are facing is not cyclical. The loss of income is not the fault of any of those who suffer from it. The cost of hesitation may be irreversible. The memory of the sufferings of Europeans in the 1920s is enough of a cautionary tale.

The speed of the deterioration of private balance sheets — caused by an economic shutdown that is both inevitable and desirable — must be met by equal speed in deploying government balance sheets, mobilising banks and, as Europeans, supporting each other in the pursuit of what is evidently a common cause.