Wallace Stevens poem ‘The Blue Guitar” describes why most are missing in their analysis or thoughts on the current EZ crisis:
The man bent over his guitar,
A shearsman of sorts. The day was green
They said, "You have a blue guitar,
You do not play things as they are."
The man replied, "Things as they are
Are changed upon the blue guitar."
And they said then, "But play you must,
A tune beyond us, yet ourselves,
A tune upon the blue guitar
Of things exactly as they are."
Paul Krugman citing Ed Harris also touched on the essential characteristic of the ECB is not that it is of the size and brawn able to digest PIIGS debt, but rather that it is a “blue guitar” which when monetary policy or financial flow goes through it – it comes out different, not exactly as they are. Like some economic Heisenberg ideal – it is not the size or any sort of demand supply algorithm that is the input for the ECB impact, it is the mere fact the ECB is at first considering the problem as an “observer” and then processes the problem on their unique “blue guitar” instrumentality.
In fact it is this role which is of importance not whether the ECB should do E 1 trillion of PIIGS or more or less than that amount. It merely has to stand ready to purchase any and all EZ debt so as to perform their central bank functionality as per the Consolidated Treaty and Protocol 4. In fact by moving from a demand supply type of tepid bond purchases to a “buy all bonds”, the ECB will in the end actually not have to buy that many bonds at all, or no bonds beyond what is required for monetary operations.
This is central banking which is crucial to a sovereign identity and in this case would be the definitive federalist act from the fledgling nation of the ‘United States of Europe”.
There is talk about legality and inflation which is really much stupidity or rather shallow political objectives or minimal understanding demonstrated. It is often coming from areas where one would think a deeper understanding would be demonstrated or the party would have recused themselves long before as their allegiance and identity is clearly regional and parochial. Weidmann and before him, Stark, are examples of incredibly adamant parochial allegiance to the Reich over and beyond identity to the greater good of the European people entire. Their thoughts about legality of ECB ability, clearly in error, cannot be explained by ignorance as both men are very capable so it must be a patriotic dedication to the Volk that fuels their striving to operate outside the very clearly defined boundaries of ECB governance and the mandate. In that way I find both men bizarrely close in ideals to those who once upon a time talked about "Lebensraum". Only now the room is digital and virtual and involved with mercantalistic export based upon a "uber" competitive market. These Germans have a curious narrow regional nationalistic economic identity which with only a few words changed morphs to a very odious political identity, indeed.
But others pile on with amazing ignorance considering their past roles or experience, such as Mervyn King cited in a recent interview for the Guardian http://www.guardian.co.uk/business/2011/nov/16/mervyn-king-defends-ecb where he states that for the ECB to purchase PIIGS debt is not a Lender of Last Resort (LLOR) operation but is a market support operation and monetization of sovereign debt, a transfer of wealth. Perhaps given the Bank of England’s ubiquitous placement in the unwritten constitution of the UK, someone with the credentials of King takes for granted the BOE role that after reading “Lombard Street” by Bagehot in Cambridge (even though his comments smack of a rather inflexible Oxford man) he is never aware of the constitutional nature of the BOE, the central bank and therefore he is not aware that the central bank is a “blue guitar” – but is just like any other financial instrument/institution in the flow of funds orchestra, only bigger and perhaps stronger and more august.
The ECB is a “blue guitar” not because Draghi is a clever fellow or that Trichet was one as well, but that it is a constitutionally defined federal instrument for all of Europe. It is the only fully birthed and defined constitutionally institution in the EZ.
Money goes into the ECB as a storage of set value and a unit of exchange – in other words like the amount in any of our bank accounts or what we owe or spend on groceries. Money in this form is scalable and whether it is one unit for a candy bar or billions for purchase of Boeing aircraft or to borrow for a highway project, this money form is basically of the same stuff. Principles of thrift and spending, perhaps with tweaking when speaking in large aggregations as Keynes did or Ricardo, work pretty much the same for a household or for a large private entity. Moral qualities can be assigned and considered and folksy anecdotes have some use when discussing this money. This is the form of money that I think the likes of King consider and is the money of the Pete Peterson Concord group fellows and the Tea Party or those who cite the Weimar inflation with integrity and honesty thought present. And as I said, it is the money that enters into the ECB, but once it enters the ECB in any form - a presentation of “covered bonds” by a system member private sector bank or the purchase of PIIGS debt - then the money changes its very nature. As this money is now played on the “blue guitar” of a sovereign central bank it is changed.
This is what Bagehot and Kindleberger talk about when they take the leadership in defining central bank theory. It is the blue guitar of monetary economics and economics in general. It is the heart of any sovereign entity and it is the essential characteristic of the Westphalia system state.
When money enters a central bank which has a constitutional mandate, and depending on the “stateliness” or august nature of the state, size then has no meaning. This money wihtin such a central bank no longer has scale. It can be several units, it can be infinite units, as it then no longer becomes a unit of savings or exchange but becomes the very stuff of seignorage and thereby the very stuff of the “full faith and credit” of the state. “E pluribus unum” – out of one, many. Only when a central bank is losing its connection or integrity to the state, or when the state is losing its integrity and infinite tenor of expected existence, does the “blue guitar” fail and money in whatever form enter and then stay the same as money for all. So the Stark. Weidmann, and King folks (Volks) of the world either do not understand implicitly the blue guitar aspect of a central bank or they are ignorant or they are dissemblers and seek to forestall or prevent the essential nation forming act of a central bank preforming sovereign duty when it starts to play the blue guitar.
For central bank actions once taken are very hard if not impossible to be undone for they are the stuff of epic historical “nation creation” and the very act is a constitutional drafting complete. And being a “blue guitar’, the ECB has to make all aware it could go to infinite amount of debt purchase and then "that will be that" as far as an understanding of the nature of EZ debt enters the market place expectations. In fact after such an understanding, the ECB, as long as it is not required to provide reserve balances or are other operations will find they can actually reduce their current holding of PIIGS debt, or rather EZ debt on the balance sheet as the market understands that all EX debt is pari passu and sovereign in nature.
The ability of the ECB to be a central bank is obvious, with a mandate that has been democratically granted by all the EZ members through their directly elected parliaments and refined in the Treaty of Lisbon and summed in the “Consolidated versions of the Treaty on European Union and the Treaty on the Functioning of the European Union” which is available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2010:083:FULL:EN:PDF . It is amazing that those who are so quick to opine and discuss the EZ crisis reflect a knowledge that clearly shows little if no reading of this critical document. Much was made of Weidmann citing Article 123 in regards to how the ECB purchase of sovereign debt was “illegal”. Perhaps English as a second language is the cause of that use of word “illegal”, but even a casual read of Article 123 shows there is at least a debate whether that applies to the ECB debt purchase (the actually language refers to a direct funding or “overdraft” to a member state by the ECB and does not even touch on the holdings of securities) and most would say its use by Weidmann was disingenuous or incorrect. Further read of the Protocol 4 which addresses specifically the ECB independence and seniority in the EZ system and then Articles 3, 12, 28,38,41,119, 127,128,129,and 282 clearly show the ECB is empowered to do anything the ECB Governing Council under the President Draghi which will support or promote the main Article 3 on the economic Union and unity and prosperity of the EZ entire. Further more Germany is only a vote amongst many - and in fact all the other ECB Board show a courageous and thoughtful non- native country orientation in their voting, but for the Germans. It is a majority rule with one vote per person with great power from the president as it is Draghi who controls the communication with other "competencies" and entities of the EZ and the research and reporting function of the ECB.
[Before you even start to think of rejoinder to this writing, or any thoughts or writings – you really cannot think clearly for yourself or enter into debate unless you read at least Protocol 4 and then the main cited articles in Protocol 4 – this is about 40 minutes of time invested.]
What is obvious is that the most time and legal crafting in the "Consolidated version.." was spent on the ECB. That the ECB was the key action and institution in the Treaty. Perhaps it is a political Trojan Horse, holding wiley Greeks sneaking into the prosperity of the seemingly impregnable Troy of the German hegemon, but that is the definition of a constitutional action – it is political.
There has been, I feel, a most deliberate coup d’etat attempt ongoing in Europe, a combination of “post-democratic” plutocrats with hegemonic recidivist Germans – both parties finding common cause for a power grab in what they mistakenly perceive as a power vacuum as Europe struggles with the messiness of democracy as shown by the failure of most referendums on the ‘Constitution for Europe”, the struggles of the Treaty of Lisbon ratification, and the chaos of smaller, mostly Eastern Europe, states piling in. The architects of a democratic and federal Europe from the days of Jean Monnet and the ECSC to the present always knew that it would be difficult to break through economic expediency to a true federal democracy. They did make a deal with the devil and hid a bit behind what others fully embraced – the Habermasian neo-Adorno complexity technical design. It was a deal with the devil which the cynicism it has evoked providing the basis for the German economic neo-Lebensraum crowd with the huge crowd of newly empowered and percs compensated plutocrats of the Euro non-elected governance.
Yet now, amidst all of this problems, is the “blue guitar” of the ECB which had only to be played and things “are no longer as they are”.
Granted the ECB has the power as per the above, but does it have the right to proceed with the essential act and form Union by commingling all EZ sovereign debt in ways that show its capacity is infinite as any sovereign entity with over 331 million populace and a EZ GDP in excess of the $16 trillion, both numbers exceeding the USA? The questions citing the size of the EZ provides the justification. If the ECB is chartered for overriding responsibility for the wellbeing of 331 million people, the sheer enormity of the responsibility insists on the answer. In any case Article 3, which the Protocol 4 use as defining the main duty of the ECB is completely clear and transparent as to not only the intent but the duty of the ECB to act in the best interest of the entire 331 million. Not German disingenuous traditions and unspoken deals on the formation of the ECB, nor non EZ members ideas as to what or should be done, but for the People of all the EZ populace. This is of course what the clear speaking Spanish Prime Minister Zapetero was driving at in recent interviews http://www.guardian.co.uk/business/2011/nov/17/spain-eu-ecb-help-bond-yields-rise
The ECB is the only federal chartered EZ institution with authority and independence and "competencies".
Therefore if it does not act and remedy the EZ crisis, no one will.
The end of this crisis without remedy is very ugly indeed involving loss of treasure and in the end loss of life, certainly loss of living standards. It will be a calamity for Europe. A major problem for the EZ is that this crisis will likely not be visited upon the US as Lehman was visited upon Europe, for I think the US has firewalled itself from the EZ crisis and also with some US recovery and surprisingly robust GDP occurring now, there will be a move to an isolationist sentiment if not some tactical satisfaction with the clipping of the wings of likes of Deutsche Bank.
But, despite these isolationist thoughts, Europe and the successful remedy of the EZ crisis is essential for US vital geo-strategic security for the next several decades, so hopefully the growing isolationist tendency will not prevent the US from assisting the ECB with this great historical moment. But Europe should be mindful when they take what they think are “free kicks” against the USA, poking at Geithner or Clinton or even Obama, being disdainful of the US and repel US interaction from habits developed over the last decade or two – they may be upsetting by doing so their only true ally who might be the deciding prompting of the ECB to take the only action possible.
The ECB should act only in terms of Protocol 4. What will that mean in terms of the remedy? The most important step is to realize that the “blue guitar” is how to proceed and not acts in ways that are not market supporting devices or plans.
The yield levels of Greece and Spanish debt are not at all the issue.
The issue is that Greek and Spanish debt are not pari passu with German or Dutch debt. That they are not full faith and credit of the EZ area. Therefore the ECB has to act with majesty and play the blue guitar – it must transact not only the problem of the week PIIGS debt, but all debt. It should determine the debt market level commensurate with a sovereign nation of the size and scope and legality of the EZ and then bid at that market level for all bonds. At first, of course, those central bank purchases will be that will be whatever is cheapest as speculators quickly locate bonds trading at 20 or 30 or 50 or 70 or 80 price and basically receive Par from the ECB. While this will seem to be an incredible largesse, actually the market will find the prices of all the PIIGS debt, in fact all EZ sovereign debt, becomes “one” quickly. E pluribus unum.
And that is the magic of the blue guitar.
If done with the full intent to purchase whatever size the market can bring to the ECB window, my guess is about 300 to 400 billion will be all that is transacted, though it must be clear to the market the ECB is ready to go to infinite size. The ECB can choose to let the reserves remain in the system or can instantly drain the reserves created through standard central bank monetary operations with either the EZ member banks or with foreign accounts, all who would be keen to assist with this important stability operation. But when the ECB conducts this sterilization, if it so chooses to do so, it should do it not in reversing out the bonds purchased but in the form of ECB letter repo. This will cal an aggregation of all EZ sovereign debt, what Hamilton called an "Assumption".
This operation, simple and qualified by Protocol 4, but action of immense power and of a massive positive impact on 331 million people, would transfer the disparate forms and valuations of the EZ members and form a country, form and affirm or define irrevocably Union. That is the transformative blue guitar power of the ECB. It would be epic and historical event in the progress and history of democratic free countries, right back to the writing of the Magna Carta. It would be celebrated as an act of institutional courage and brilliance for centuries to come. It would immediately end the crisis and in fact slingshot the EZ to full equivalency on the world stage with the USA.