Nice to know that the euro is in such good hands

By now, presumably the whole world knows that Mario Draghi, President of the European Central Bank, has announced that  'Within our mandate, 'the ECB is ready to do whatever it takes to preserve the euro.  And believe me, it will be enough'.

On the face of it, that statement was reassuring enough that 'risk on' trades were on again, world equity markets surged, and gold and silver rose nicely a week ago Thursday.

But what else did Draghi have to say on that occasion?  Nickolai Hubble, writing in The Daily Reckoning Australia for Wednesday, August 1, "How the ECB will Print Money, and Buy Bonds" (, dissects Draghi's rhetoric and the thoughts they were intended to convey, for our edification and reassurance. I laughed, until I cried, at this.

Also, Bron Suchecki had an interview with Larry Klutz on FinancialSenseNetwork ( that has apparently not attracted the audience I think it deserves, as I have not seen it linked elsewhere.  The twenty minute interview is well worth the time needed to listen to, as it points out an apparently not very well known factor in why premiums for gold and silver coins were so high when metal prices were so low back in 2008-09.  Bron's Gold Chat site (, for 25 July 2012) has the above link to the interview, as well as a synopsis that presents his basic point, which is that mints cannot readily increase production of gold and silver coins, even when demand increases greatly, because there is a bottleneck that mints cannot afford to remove. That is not the scarcity of physical metals or their ability to quickly stamp out the coins themselves, but the limited supply of the blanks, or planchets, that feed into the presses.  They are made through very complex and expensive processes, and their supply cannot be increased quickly or easily since the major capital investments that would be necessary to do so in future cannot be justified under present circumstances.

A later posting on Bron's Gold Chat answers a number of readers' related comments and questions.

Contributed by Slow Loris Larry


Warren James said...

I have a few random comments on this:

1. I did happen to read the Daily Reckoning write-up (unfortunately I can't find a website link to that). In it, I thought Nickolai Hubble was being a little unfair - the ECB always has the 'nuclear option' (gold revaluation) at their disposal, but they would prefer to see everyone get their finances in order rather than be seen to be 'responsible for triggering' the collapse of the value of sovereign debt. So for outside observers we see a lot of fluff and noise while the people in charge try to fend off the easy money junkies.

My trade went the other way though. While I knew (from Freegold theory) that the ECB would refuse the idea of euro bonds, I did think the news would send the AUD weaker. Instead it seems to have gone the other way. oops.

2. The big coin presses they use at the mints are quite amazing - not surprising when you see the fine artistry on Perth Mint coins. In my refiners research I saw a writeup of some of the plant & equipment at Perth Mint (sorry, can't find the link anymore, I was doing superannuation research). The perception is always that mints have lots of silver and gold they must be rich, but they are a business just like any other, and their working stock is effectively bought and sold at spot price with a premium added. I remember in 2011 a lot of hype with the shortage of retail products (stamped coins & bars, etc) being interpreted as a shortage of the raw stuff. I even got excited a few times when some online shops had appeared to be running out of inventory with 'sold out' items appearing everywhere.

:) Warren

Bron Suchecki said...

There certainly is a perception that the Mint's "own" their inventory, which is understandable as that is what conventional business do so people assume the same applies to PM businesses.

The shortage issue is the same again, with people seeing shortages at their retail coin dealer and assuming the same across the industry.

Anonymous said...

It seems that most people don't understand the ECB. If Draghi says "within their mandate", he is referring to their inflation target "below but close to 2% annually" in the medium term (i.e. 2-3 year average).

He said he would save the Euro "whatever it takes". He didn't say he would save government debt whatever it takes. Some people seem not to get it that these two are completely different goals.

If you take the 2% inflation target seriously (and every single step by the ECB is consistent with the assumption that they do), you conclude that:

1) The ECB will print money in order to create inflation as soon as the medium-term inflation rate gets substantially below 2%.

2) In order to create this inflation, the ECB will have to purchase consumer debt with new base money (this is how you create price inflation). So their standard choice will be to buy government debt - government expenditures are largely consumption, either directly or through salaries, pensions, benefits.

3) In the inflation rate drops substantially below 2% in some countries, but not in others ("policy transmission distorted"), the ECB will buy government debt of these countries, but not of others - most governments spend mainly in their own economy which allows the ECB to target where they want to create inflation


Anonymous said...

4) The ECB has no mandate to create more inflation than the mentioned 2% annually. So they will make sure this doesn't happen either.

5) How will they do it? Well, that's easy. A lot of debt is being written off (Spanish home owners defaulting on their mortgages etc.), and several governments had to sharply cut down on their deficit spending. Both are deflationary. So the ECB could simply leave the market alone, and the Euro zone would get some price deflation. So the ECB has enough tools to limit the inflation rate at 2% annually.

6) What is the main mechanism that might cause an inflation rate higher than 2% in the medium run? This would happen if the commercial banking system or the ECB monetize the running budget deficit of their governments or if they monetize other consumer debt beyond about 2-3% of GDP annually.

7) How can this be prevented? Well, some governments have gotten into serious difficulties raising funding, and Ireland, Portugal, Greece, Spain are forced to cut down on public spending. How precisely? The interest rates they would have to pay for additional debt are going up.

See? Some idiots claim "Draghi wants to print and buy all government debt in order to lower the interest rates" and then "ECB is too stupid to really lower interest rates"?

How about this: ECB has purchased some government debt in order to create inflation in those countries in which inflation was dropping too much below 2%, but ECB never intended to lower interest rates?

Much easier explanation, isn't it?


Anonymous said...

8) So what do we conclude if we assume that the ECB is doing nothing other than their job, i.e. to maintain their 2% inflation target?

8.1) They will buy government debt if the inflation rate drops too much below 2% annually. In particular, if this happens in some countries, the ECB will buy the government debt of these specific countries (SMP).

8.2) Although the ECB may buy government bonds for this reason, they will make sure they do not artificially suppress the interest rates (in contrast to the Fed or the BoE).

8.3) As long as the inflation rate stays around 2%, the ECB will not monetize government debt, simply because this would create more inflation. In particular, this indicates a limit of the annual budget deficits that will end up on the balance sheet of the combined banking sector (commercial banks and ECB): no more than around 2-3% of GDP which would cause about 1.4-2.1% consumer price inflation in the steady state (assuming roughly 70% of government expenditures is consumption - you can adjust these figures if you have better data, the ECB certainly do have better data).

8.4) So while some debt will be bought by the ECB in order to maintain 2% inflation, some other debt will most likely be defaulted on. How much? I guess this will still be a lot.

8.5) If some politicians try to give the ESFS or ESM a banking license or to use government run banks in order to monetize their own debt, the ECB will have to obstruct these attempts, for example, by changing the requirements on the collateral they accept from these banks. Also, the northern countries will not like this and presumably already be influential enough to stop it.