QUESTION: Hi Martin,
Awhile back you mentioned the ECB doesn’t have unilateral authority to expand the money supply, and that the political crisis in Europe would begin once the ECB ran out of cash reserves. How far off are we from that moment, and how does the Repo crisis tie into that?
ANSWER: Yes. To be clear, the Fed can create physical dollars to buy federal bonds to back the currency. The ECB simply has the power to create euros through its member banks, but there are no consolidated federal bonds to back the currency. This means that the ECB relies upon the consent of member states to be able to expand the money supply. That structural difference would be as if the Fed needed the approval of all 50 states to print dollars.
The very backing of banks is also substantially different. In the USA, reserves are held exclusively in US federal government instruments. In Europe, they have holdings of various member state debts. Since they have rejected the consolidation of debt, this also extends to the BAIL-IN policy. If banks are in trouble, the ECB could only lower rates. It cannot bail out banks in Italy for that would mean that money would flow from Germany to Italy. That is contrary to the no consolidation of the debt rule.
This is really one giant structural mess that I do not see being addressed until the system implodes. Only then, maybe, will the politicians revise the system or face the collapse of the entire EU structure.