If you needed anymore proof that the euro is on the verge of collapse, Yanis Varoufakis’s article should help confirm it. With the ECB holding interest rates at near zero and having pumped over 1 trillion into the system via LTRO, Christian Noyer (governor of the Central Bank of France) provides the strongest hint yet that nothing has worked.

Under normal conditions, the interest rates that you and I must pay on a home loan, a car loan, our credit card, a business loan are pegged onto two crucial rates. One is the rate that banks charge one another in order to borrow from each other. The other is the Central Bank’s overnight rate. Alas, neither of these interest rates matter during this Crisis. While such ‘official’ rates are tending to zero (as Central Banks try to squeeze the costs of borrowing to nothing), the interest rates people and firms pay are much, much higher and track indices of fear and subjective estimates of the Eurozone’s disintegration.

After 2008, banks failed to lend to each other.

Following the Crash of 2008, banks stopped lending to each other, fearful that they will never get their money back (as most banks became, in effect, insolvent). Thus, the interest rate at which they lend to one another simply ceased being a meaningful price (just like the prices of CDOs, following Lehman’s collapse, lost their meaning as no one bought or sold those pieces of paper). The truly scandalous aspect of the Libor scandal of recent weeks is that banks continued to use (and ‘fix’) an estimate of the interest rate at which they lent to each other (for the purposes of fixing all other interest rates; e.g. mortgage and credit card rates) when they did not lend to each other any more…

The ECB took action by lowering interest rates and stopped paying interest on overnight deposits hoping to force banks to lend.

the ECB lowered its key interest rate to 0.75% – the lowest level since the euro’s inception. At the same time, the ECB did something else that is extraordinary by its own standards: it reduced to zero the interest rate it paid private banks for depositing money with the ECB.

…….

and having no incentive whatsoever to park their idle capital with the ECB, one might have hoped (as the ECB’s President, Mr Mario Draghi, clearly did) that banks would be more willing to lend and at a lower interest rate. However, such hopes would have been baseless.

Noyer admits the system is bust.

“We are currently observing a failure of the transmission mechanism of monetary policy. From the markets’ perspective, the interest rate facing individual private banks depends on the funding costs of the state where they are domiciled and not on the ECB overnight interest rate… Hence the monetary policy transmission mechanism does not work.” Now, this is an admission that should be on every headline in Europe, given that it comes from a governor of the Central Bank of the Eurozone’s second largest economy.

The admission gets even better. He alludes to the fact that LTRO did not have the desired affect.

“We did our best to face up to this phenomenon which is unacceptable for a Central Bank in a monetary union.” What did he mean by that? The clue comes from his follow up sentence: “In future we cannot rely endlessly on a system where the Central Bank is injecting massive liquidity to the banking system, boosting hugely its balance sheet.” Clearly, Mr Noyer was referring to the LTRO; the ECB’s attempt earlier in the year to ‘fix’ the ‘transmission mechanism’ by pumping 1 trillion euros of liquidity into the Eurozone’s banks. Reading between the lines, it is clear that, at least according to Noyer, this ploy failed (as some of us kept saying it would).

You can’t jump start a dead battery.

In short, the fear of a disintegration of the Eurozone (that is aided and abetted by silly talk of Greece’s and Portugal’s expulsion) has broken the umbilical cord that normally connects the ECB’s overnight rate with actual borrowing costs of the private sector. Now, the later reflect the fear that the member-state in which the firm or the household are will not be able to refinance itself. In a never-ending circle this fear ensures that the said member-state will not be able to refinance itself and, crucially, guarantees the ECB’s failure to lower interest rates even when it pushes its official rates to zero. This is what a monetary union on the verge of collapse looks like.

Source: http://yanisvaroufakis.eu/2012/07/17/it-is-now-official-the-eurozones-monetary-transmission-system-is-broken/

Advertisements