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Busch: ECB Is Not the Fed

Friday, 21 May 2010 | 10:26 AM ET

The calamitous actions and inactions by European officials continue to drive uncertainty throughout the financial markets.

Overlaid on this, we’ve had fears generated from Australia’s commodity tax, China’s warnings on inflation, weaker than expected US inflation and economic data, the US financial regulatory reform legislation, and finally the retail pullback ($12 billion out) from equities generated from the Flash Crash. It’s a revisit of the sequential bad news that came out in early 2009.

A conspiracy of bad things happening quickly.

There is one major difference and it has to do with central banks.

Martin Barraud | OJO Images | Getty Images

The US and UK central banks (and treasuries) eventually decided that their alphabet soup of liquidity provisions were not enough to stabilize the markets.

Two things happened to help stabilize the markets. One, Ben Bernanke announced on 60 Minutes that no major US financial institution would fail.

Two, he announced a quantitative easing program that ballooned the Fed’s balance sheet to over $2 trillion and flooded the markets with US dollars. After the US stress tests were done in March, the economy and equity markets recovered.

This contrasts sharply with what is occurring in Europe.

The Bank of Northern Europe (BNE) or more commonly known as the ECB has announced a qualitative easing program.

In this program, they said that they would:

1. To conduct interventions in the euro area public and private debt securities markets (Securities Markets Programme) to ensure depth and liquidity in those market segments which are dysfunctional. The objective of this programme is to address the malfunctioning of securities markets and restore an appropriate monetary policy transmission mechanism. The scope of the interventions will be determined by the Governing Council. In making this decision we have taken note of the statement of the euro area governments that they “will take all measures needed to meet [their] fiscal targets this year and the years ahead in line with excessive deficit procedures” and of the precise additional commitments taken by some euro area governments to accelerate fiscal consolidation and ensure the sustainability of their public finances. In order to sterilize the impact of the above interventions, specific operations will be conducted to re-absorb the liquidity injected through the Securities Markets Programme. This will ensure that the monetary policy stance will not be affected.

The European Debt Crisis - See Complete Coverage
The European Debt Crisis - See Complete Coverage

This is the major issue for Europe: they have a central bank that is following its mantra of inflation fighting in the face of a crisis that could destroy not only the European Union but cause a depression for Europe.

Have they not researched the 1930s? Have they not been engaged from 2007-2009? Have they not learned from the US/UK?

Trichet and Weber are the personification of Ralph Waldo Emerson’s hobgoblin of little minds: they remain consistently focused on inflation while deflation and the economy sink.

It is almost incomprehensible that they would sterilize the bond purchases that they are doing to “stabilize” the markets. They’re move has actually destabilized the markets already. I feel remiss in that I believed they would not sterilize these purchases. My thought was they would not only allow the Euro to depreciate, but also pump money into the European economies to help southern Europe grow. This would help the PIIGS fiscal situation with tax receipts increasing with growth.

Sadly, I was wrong and the ECB announced a 1% mop up facility to drain the liquidity it provided.

How can they possibly do this? To me, this is the path towards default for Greece that the ECB prefers.

What is the market’s reaction?

The markets bought back their Euro currency shorts and sold European equities as they dumped risk. Overall, this is a major vote against the current ECB policies and a major vote against the policy making capability of the European Union. Until the ECB engages in Fed like behavior, Europe will suffer and the bottom for European equities will be unknown.

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Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.

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