I haven’t completely sorted this out yet but for a number of reasons I believe that the ECB has lost control of monetary policy in the Eurozone.

By that I mean the ECB is no longer controlling the marginal cost of funding and that indeed the cost of such funding is rising much higher than the official 1.25% rate, at least up to 2.25% and perhaps as high as 6 – 7%.

This incredibly contractionary monetary “policy” began sometime earlier this year and is continuing to accelerate. I put policy in scare quotes because there is no policy as such there is simply contraction.

Paul Krugman and Joe Weisenthal look at the growing spread between Sweden and Finland and conclude that failure of the ECB to act as Lender of Last Resort explains the difference. This is a position I would have endorsed as recently as yesterday, but now I am not so sure.

Based on entirely different indicators this looks to be the point where the ECB’s control over Eurozone monetary policy began to come unmoored.

At the crux of the problem seems to be the inability to arbitrage away differences in funding costs between institutions and countries because of malfunctioning in the European Repo market.

This malfunctioning appears to be down right mechanical with trades regularly not settling on time, collateral not being delivered, awkward interventions by local regulatory agencies and a host of other deep, deep problems.

I don’t have it all sorted out but its not clear that there is a fully functioning money market in Europe right now. Well informed opinion suggests that there is literally a shortage of know-how on the ground. That is to say, some large banks or brokers cannot trade in certain types of paper because they don’t have anyone on staff who knows all of the relevant institutional details.

Its really maddening and quite disconcerting.

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