Draghi’s rescue plan is “tantamount to financing governments by printing banknotes”

Yesterday Mario Draghi, president of the European Central Bank, announced that policy makers had agreed to an unlimited bond-purchase program which is designed to suppress interest rates within the eurozone and prevent a breakup of the currency union.

Speaking at a news conference at the bank’s headquarters in Frankfurt, Draghi said, the program “will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro”.

The latest plan to save the euro is the most ambitious yet, and aims to cut the borrowing costs of debt-burdened eurozone members by buying their bonds. Draghi described the new measures as, “a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.”

Draghi’s plan

The bond purchase program, which has been dubbed Outright Monetary Transactions or OMT, will buy government bonds with a maturity of 1 to 3 years in the secondary market. The EU Treaty prevents the ECB from purchasing government bonds in the primary market, however, under Article 18 they are allowed to do so in the secondary market.

The ECB can only begin purchasing the bonds of countries that qualify for the OMT program once their governments request aid from Europe’s rescue funds, the EFSF/ ESM. Any nation requesting help must also accept various fiscal and reform conditions that are stipulated by Brussels.

Opposition to the plan

Stock markets around the world seemed to be impressed by Draghi’s plan with the S&P 500 index in the US up 1% to within a few points of a high for the year. The Eurofirst 300 index rose 2%, Spain’s Ibex 35 rose 3.2%, and Italy’s FTSE Mib rose 3.7% to a four-month high.

However not everyone was convinced by the ECB’s latest plan to restore price stability in the euro area. In fact, Germany’s Bundesbank publicly voiced its opposition to the bond-buying plan with Bundesbank President Jens Weidmann describing it as “tantamount to financing governments by printing banknotes”.

This was also the conclusion of gold investors as they bid up the price of the yellow metal from an opening price in New York of $1,695.70 to as high as $1,716.90 per ounce.

Flawed thinking

The reason that global stock and bond markets rallied at the prospect of more massive bond buying by the ECB is this:

Almost all contemporary macro economists, monetarists, supply side economists, and even financial journalists subscribe to the Keynesian economic philosophy. As a result they believe that stable economic growth requires a positive rate of credit expansion, and that such an expansion can perpetuate an economic boom.

To these people the proper aim of monetary policy is, and should be, to keep new money flowing through credit markets at a rate that’s sufficient to maintain low interest rates and to keep stoking the boom while minimizing price inflation.

The problem, however, is that these New Keynesian principles are deeply flawed and have been universally discredited.

You cannot print your way to prosperity. It works for a while but it takes larger and larger doses of stimulus spending to prevent a collapse, and eventually you end up destroying your currency. If printing money was the key to economic prosperity then Latin America would rule the world today.

Printing money is the last refuge of failed economic empires and banana republics.

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