Dear Mr. Draghi

Yesterday you announced a further „easing“ of monetary policy by the European Central Bank (ECB). In order to stimulate the economy in the euro zone you will take the following measures:

First, the ECB will cut its deposit rate from -0.2 per cent to -0.3 per cent. Second, the rate for main refinancing operations will remain unchanged at 0.05 per cent. Third, the ECB will expand its stimulus program by buying government bonds until March 2017.

However, the size of the ECB’s monthly bond-buying program will be unchanged at 60 billion Euros per month. With those measures you would like to boost the inflation rate in the euro zone up to two percent.

Unfortunately, the argumentation of the ECB is based on several fundamental errors. Please let me try to explain to you the three most severe misunderstandings.

The deposit rate of the ECB is an interest rate on the liabilities side of the balance sheet of the ECB as deposits are liabilities of the ECB. If the ECB is lowering its deposit rates further into negative territory this is not an expansive but rather a restrictive monetary policy.

Why?

By lowering the deposit rate further into minus territory, this means, that the banks must pay more interest rates to the ECB. Therefore the ECB is not supplying the economy with additional capital („lender of last resort“) but rather raises foreign capital from the economy. This clearly is restrictive.

Lowering deposit rates further into negative territory by the ECB has got the same impact on the economy as if the ECB is raising its rate for main refinancing operations on the asset side of its balance sheet.

The ECB therefore is not at all stimulating the economy by lowering deposit rates but rather is depressing it.

Second misunderstanding. The balance sheet of the ECB is always balanced. The ECB can only invest as much into government bonds on the asset side of its balance sheet as it raises foreign capital on the liability side of its balance sheet.

In other words: The ECB raises capital on its liability side and this very capital it reinvests on its asset side. Therefore the so called „stimulus program“ of the ECB which you, Mr. Draghi, announced yesterday is merely a zero sum game.

However, this is a dangerous zero sum game. Why?

Commercial banks and institutional investors must not take the risk themselves anymore of investing directly into government bonds, for example of Greece. They rather invest into „secure“ deposits of your ECB with a better rating. The ECB then is taking the risk on their behalf of investing into government bonds of Greece.

By this the quality of the ECB rating is diluting.

In the end tax payers are taking the ultimate risk of the investments of the ECB into government bonds of countries with a lower credit rating than the ECB.

If interest rates rise and/or prices of government bonds are falling as a result of a lower rating, it may happen, that the equity ratio of the ECB is falling to zero and below. In case equity of the ECB is falling into negative territory, those credit institutions which gave credit to the ECB must write down their investments at the ECB accordingly.

This may lead to bankruptcy of commercial banks in Europe. In such a case the ECB cannot „print money“ to pay back its debt as central bankers, politicians and journalists often pretend. In contrary: Bankruptcy of commercial banks, as a result of negative equity of the ECB, may lead to a severely economic and even political crisis.

Third misunderstanding: The ECB as well as other central banks are worrying about low inflation rates or even slight deflation. However, there is no reason for worrying about lower prices. Why? Let me explain.

The famous so called „Phillips Curve“ is showing a „trade-off“ between inflation and unemployment. If unemployment is high, inflation is low and vice versa.

By reading Phillips original text „The relation between the unemployment rate and the rate of change of nominal wage rates…“ in „economica“ (1958) carefully it becomes clear, that Phillips stressed the point, that his curve was correct only in times of a change of aggregate demand when aggregate supply was constant.

Having said this, the Phillips Curve is, in economic words, nothing else than an aggregate supply curve along which the demand curve is shifted. In this case all intersections of supply and demand lie on the stable supply curve.

However, if there is a supply shock and oil prices rise, the supply curve is shifted upwards itself. The result is stagflation i.e. inflation and unemployment rise together.

On the other hand, if oil prices fall, inflation and unemployment fall together. Therefore „deflation“ does not automatically mean „depression“ as todays central banks misunderstand.

There is a „good“ deflation and a „bad“ deflation. In case of a „good“ deflation the economy is stimulated. This happens today by lower energy prices. They stimulate the economies.

The conclusion is: Falling prices do not necessarily mean a higher unemployment rate. If prices fall as a result of falling supply, unemployment falls as well.

Nowadays prices do fall as a result of lower energy prices. Therefore central banks must not worry about lower prices as they stimulate the economy.

Dear Mr. Draghi, I hope I was able to show to you some severe misunderstandings in economic theory. Economics is a very important science. And it is necessary that there are no such misunderstandings as I tried to figure out in my letter to you.

It cannot be the duty of the central banks to invest in government bonds of lower quality just because they do not get credit themselves from commercial banks and institutional investors.

Of course commercial banks and institutional investors prefer to invest in liabilities of the ECB rather than in risky government bonds. On their behalf the ECB and tax payers take the risk of the subprime government bonds. This is a free lunch offered by the tax payers and the ECB.

By taking credit from credit institutions and investing this very capital into bonds of governments with a lower rating, the quality of the ECB is diluting.

The ECB is throwing good money after bad.

In worst case this may lead to bankruptcy of credit institutions and in the end tax payers will have to recapitalize the ECB.

Sincerely yours,

Marc Meyer

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  1. After my observations volatility in FX started started nine minutes before the decision ( 13.36 ), and first view of the publication (FT, London) was also 13.36 (Frankfurt Time).
    It is not very likely, that so many people have seen the publication and started within the same minute with big FX operations.
    The case looks designed.
    FX-traders in London are not allowed to place their bets before the announcement.
    Nothing else happened.
    Later Mario Draghi (at press conference 14.30) was rather confused.
    Seems to me, that somebody else has changed his decision in the very last minute.

    • @Hugenberg

      Dear Mr. Hugenberg

      Thank you.

      How do you mean your last sentence? I do not really understand what you mean. It would be interesting, if you could explain your point.

      Thank you

      Marc Meyer

  2. At Thursday, 3rd. of December 2015 something really freightening happened between the FED and the ECB.
    There were unable to find a agreement about currency exchange level between EUR and USD.
    So we saw following scenario:
    In the morning of Thursday (3rd of December) the EUR/USD rate went down to 1,0540, admitting to go lower if Draghi would deliver.
    Delivery time for Draghi was 13.45 european time.
    At 13.36 european time there was a false article from the Financial Times in London, that Draghi a) did not change the repo rate ( -0.2%/unchanged) and stayed at the monthly volume of 60 billions.
    Immediately EUR/USD soared to 1,0670 and was shaken by huge volatility from that point.
    At 13.45 european time Draghi showed parts of his decision with a increase in the repo rate ( -0,3% instead of -0,2%) and EUR/USD went further to 1.0750.
    During the following press conference he does not deliver what was priced, in and EUR/USD went to 1.0978 later.
    So my suggestion is that that was a huge intervention by the FED to protect their export business in Europe and nothing else.
    A change of 438 pips cannot be rectified by false market positions.
    The americans want to increase rates and preserving their revenues from the european business at the same time.
    Yes we can.
    So anything can be managed today, even higher rate differentials with no effects on the exchange rate.
    You can see it if you look at the oil price from today.
    Under USD 40,00 it means nothing else as the ultimate war declaration to Putins empire.
    Nobody sacrifies his own shale industry for nothing.

    • Dear Mr. Schacht

      Thank you for your analysis. The markets were very nervous before Draghis speech.

      Interesting is the wrong article in the FT. It seems that medias are misused to influence the markets rather than report from the markets.

      May I correct you? This was not the repo rate but rather the deposit rate.

      It will be interesting how the FED decides next week and how the markets will react.

      Kind regards

      Marc Meyer

    • Dear,

      Absolutely correct.

      ECB decided under guidance of the FED.
      Who guides the FED is another Topic…

      But I don’t believe that the intervened with markets transactions.
      Almost everyone was crazy before the meeting and talking about an FX rate of 1. Surely many had outstanding derivatives on this bet.
      This is called short squeeze…

      Most likely for the FED Meeting:
      increase of 0.25 and at the same time the clear message that there will be another 0.25 increase to destroy China and that’s it. Well, obviously they won’t mention China…

  3. Sehr geehrter Herr Dr. Meyer,

    nach meiner Beobachtung sind die Presse-Konferenzen der EZB in folgenden Teilen irreführend:

    1.
    Mario Draghi behauptet stets, daß der Wechselkurs (oder die Regulation desselben) zwar zur Erreichung des Inflationsziels beiträgt, aber nicht Ziel oder Inhalt der EZB-Politik darstellt.
    Am Donnerstag wurde dies nachhaltig widerlegt.
    Um nicht eine weitere Überbewertung des USD zu begünstigen, wurde auf Weisung der US-Exportwirtschaft EUR/USD von 1,06 auf 1,10 korrigiert.
    Ein anderes Ziel hatte die EZB-Pressekonferenz vom 3.12. nicht, dafür waren die Aussagen zu dünn.

    2.
    In Absprache mit der FED wurde damit die für den 16./17. Dezember anberaumte Zinserhöhung im US-Raum begünstigt, da die weitere Aufwertung des USD gestoppt wurde und damit ein bedeutender Hinderungsgrund wegfällt.

    3.
    Alle Beiträge von Ihrer Seite münden in die Konklusion, daß eine Risiko-Verschiebung von privaten Adressen (z.B. Banken) hin zur Zentralbank-Bilanz erfolgt. Die Zentralbank sichert also ganze asset-Klassen gegen (durch Rating-Agenturen) festgestellte Risiken ab.
    Im Falle der SNB könnte man ähnlich argumentieren: sie sichert das Risiko eines hohen Frankenkurses im Dienste der schweizer Exportwirtschaft durch Aufblähung Ihrer Bilanz ab und besorgt sich bei dieser Gelegenheit asset-Klassen (z.B. US-equities), die andere Zentralbanken gerne wertstabil sehen wollen.

    Sollten diese Beobachtungen alle zutreffen, sind Zentralbanken keine „Lenders of the last resort“, sondern lediglich öffentliche Risikopuffer zugunsten einiger ausgewählter Großbanken und Industrie-Komplexe.

    Im Krisenfall wird dann die eine oder andere Zentralbank geopfert, und die zugehörigen Volkswirtschaften mit den Negativsalden belastet. Und da es von den Zentralbanken nicht so viele gibt, und die SNB mit Ihrer aufgeblähten Bilanzsumme eine Spitzenrolle einnimmt, könnte ich mir mittlerweile vorstellen, daß sie einen geeigneten Kandidaten für eine Zentralbankinsolvenz gefunden haben.

    Insofern wären ihre Überlegungen dahingehend zu ergänzen, daß die bilanziellen Buchungsfehler der SNB kein Zufall sind, sondern in der Absicht erfolgen,
    eine von der FED und EZB weit entfernte Zentralbank zugunsten derselben hochgehen zu lassen.

    In diesem Falle wären Sie im Recht.

    Sie, verehrter Herr Dr. Meyer, hätten eine Pleite à la enron bereits im Vorfeld enttarnt.

    • Dear Sir

      Thank you very much for your excellent comment.

      Its a pitty that you did not write your text in english as I think you express the problem perfectly.

      Central banks ar not lender of last resorts but rather „risk buffers“ for selected big investors.

      Pls. compare my text „Zentralbanken, die gigantischen Kreditwaschanlagen“, IP).

      Thank you very much. You really got the point.

      Marc Meyer

      P.S. A bancruptcy of the Swiss National Bank would be much worse than Enron. This would trigger shockwaves on the financial markets worldwide.

  4. Kann Herr Dr. Meyer kurz die exakten Mechanismen ganz präzise erklären? Ich dachte immer, dass die Banken der Zentralbank repofähige „Papiere“ anbieten und die Zentralbank diese nach Bedarf ankauft. Als „Bezahlung“ schreibt die Zentralbank den Banken Giroguthaben in CHF gut (auf der Passivseite der Zentralbanken-Bilanz, auf der Aktivseite der Bilanz der Banken), während die (eventuell vorübergehend bis auf Termin) übernommenen Papiere in die Aktiva der Zentralbank gebucht werden. Nun verstehe ich es so, dass bei einer negativen Deposit-Rate die Giroguthaben der Banken bei der Zentralbank reduziert werden oder andersherum gesagt, dass bei der Umkehrung des Vorgangs, also wenn die Bank die zuvor der Zentralbank „verkauften“ Papiere wieder zurückkauft, sie für das zuvor von der Zentralbank gewährte Giroguthaben weniger von ihren „Papieren“ zurückerhält. (Bei einer positiven Deposit-Rate erhielte die Bank den Ueberschuss in Form einer (zusätzlichen) Girogutschrift.) – Danke für eine präzise Darstellung Schritt für Schritt.

    • @Elmar Hörig

      Dear Mr. Hörig

      Thank you.

      First: As this is an open letter to Mr. Draghi I would appreciate, if we could lead the discussion here in english.

      Second: This is a discussion rather regarding the ECB than the SNB.

      Third: You are right. If a central bank is lowering deposit rates (liability rates) further into negative territory it will pay back this foreign capital with a discount to the creditor bank rather than with a premium.

      Also expressed in such terms, it becomes clear, that negative interest rates on the liability side of the central bank are not an expansionary but rather a contractionary (restricitive) monetary policy.

      The central bank is paying back to the economy less capital than it raised from the economy.

      kind regards

      Marc Meyer

  5. Dear Dr. Meyer,

    it was a pleasure for me and my staff at the ECB in Franfurt to receive your comments about our decisions on the press-conference of Dec. 3rd, 2015.

    Allow me to answer to your statements as follows:

    1.
    Target of our monetary policy is price-stability by warranting an inflation in the Euro-region of approximately 2,0%. For that purpose we have introduced our QE-program in January, 2015 with bond-purchases of 60 Billion Euros monthly.
    Übersetzt:
    Aus der Sicht der Banken übernehmen wir Risiken im Bereich der Staatsanleihen und der Corporate Bonds zu 100% (face value).
    Das sollte den Banken 0,3% Strafzins wert sein, da wir die assets der Großbanken durch unsere Käufe zwischen 30% und 40% aufwerten, sodaß die Banken-Bilanzen Gewinne ausweisen.
    Die haben es ohnehin schwer genug mit den Kreditausfällen, z.B. in Italien (stat EUR 150 Mrd nun 313 Mrd. bad loans).

    2.
    Caused by signficantly decreased price levels in the energy sector, we face a drop in inflation-levels in spite of our measurements. In the case the energy-pricelevel will stabilize you can be sure that you can see the favourable results of our QE-program in the increasing inflation-level near or slightly under 2 percent.
    Übersetzt:
    Selbst bis ins Lächerliche reduzierte Öl-Preise haben nicht dazu geführt, daß die Wirtschaft global an Fahrt aufnimmt. Es ist nicht abzusehen, welche weiteren Maßnahmen ergriffen werden müssen, um eine deflationäre Entwicklung im Euro-Raum zu verhindern.
    Mittlerweile sind mit Nullzins und Energie-Preisniveau zwei wichtige Trumpfkarten ohne Effekt ausgespielt worden.

    3.
    The rate of unemployment has decreased significantly, even in peripheral states as Portugal and Spain, for example. For the whole european area we see moderate improvement also in other economical factors and will look forward to improve this factors at a faster pace until 2017.
    Übersetzt:
    Obwohl wir das Preis- und Lohnniveau in den Krisenstaaten abgesenkt haben und Maßnahmen zur Verschlankung der staatlichen Strukturen gesehen haben, konnten wir nicht vollständig sicherstellen, daß die Großbanken und die Konzerne in Europa bilanziell einwandfrei dastehen. Es ist anzunehmen, daß wir in Europa durch Einführung von negativen Sparzinsen, Bargeldverboten, Bail-Ins bei Bankenschieflagen und rücksichtsloser Ausbeutung der rechtlosen EU-Bürger (siehe Griechenland und Zypern) die Voraussetzungen schaffen können, damit aus der Konkursmasse der Lehman-Pleite möglichst viel für unsere Eliten übrigbleibt.

    Let me assure you, that the council and I will take further actions to achieve our goals in 2016 within our mandate.
    And believe me: it will be enough.

    Sincerely yours,
    Mario Draghi

  6. Follow up 1

    Obviously Mr. Draghi had a speech yesterday evening in the Economic Club of New York. There he stressed the point, that he will do everything to push up inflation to two percent.

    Mr. Mervyn King, former Governor of the Bank of England, ridiculed Draghi that he did not convince the markets as the Euro shot up and the share markets down.

    Let me explain:

    First: It cannot be a target for a central bank to put inflation up to two percent. As I wrote in my article above lower prices nowadays are the result of cheaper supply prices. I.e. inflation is low as a result of cheaper energy prices. Those lower prices are boosting the economies.

    Everybody is happy when he can pay lower energy prices. So this is good deflation not bad deflation.

    Second: By lowering deposit rates from -0.2 to -0.3 the European economy is not stimulated but rather depressed. I have given the explanation in my article.

    Third: The euro was in the past weeks much oversold against the US Dollar with regard to the decision of the ECB. So there was just a technical reaction in the markets after the speech of Draghi.

    Marc Meyer

  7. Ist es nicht naiv zu glauben, dass ein Agent wie Draghi immer im Interesse der KMU-Wirtschaft und kleinen Leute handelt??

    Meine These:
    Draghi und seine Auftraggeber sind nicht blöd. Sie wissen genau was ihre Aktionen für Folgen haben.

    • @Mr. Peter Keller

      According to my view Mr. Draghi is a representative of mainstream economic theory.

      rgds

    • @Sandra Niggli

      Unfortunately there are always people who are not interested in a constructive discussion.

      Sorry, you waste my time.

      rgds

    • Excuse me but I think its written quite good.
      But keep hating you son of a b…..
      Shu. the f….. up and if you think you could do it better show me.

    • A good one Sandra 😉 – pitiful protagonist not having other platforms to exhibit himself.
      Mark you’ve got my sympathy.

  8. I’m eagerly avaiting Mr. Draghi’s counter arguments to Marc Meyer’s apparently plausible chain of reasoning. Unfortunately, however, I do not believe Draghi is reading IP. Therefore, I would urge Marc Meyer to try to have his piece published in the Financial Times.

    • Thank you.

      May be you are right.

      I have never published in English. It seems that I should start to do so.

      Kind regards

    • Thanj you

      I am not teaching in room 33 but 19/20.

      So you should appear there.

      But I advise you to improve your English first as I do not quite understand what you want to say ecactly.

      Kind regards

    • My Dear

      If you say or write something wrong, I tell you and then I explain to you, why you are wrong. I do not just say „you are quite wrong“.

      So therefore please try to explain in english language, why I am wrong.

      Then we can have a discussion here.

      Kind regards

      M. Meyer

    • @ Nico Hauser

      Thank you.

      If only Mr. Draghu would read it as well.

      Kind regards

      Marc Meyer