Grillo's Corner with Graham McDevitt: Update on Europe
December 6, 2011
The latest phrase making the rounds of the financial media and market participants is that the European Central Bank (ECB) is “going all-in.” This phrase is particularly perplexing to us as market participants now seem to be all but begging the independent central bank for a market bailout. Anglo-Saxon countries, it seems, have gotten used to monetary bailouts from the Federal Reserve and the Bank of England. While the U.K. is actually trying to practice fiscal discipline, U.S. citizens enjoy monetary bailouts without the significant requisite fiscal austerity measures that other countries are being forced into. The Federal Reserve’s justifications for this monetary gift include its dual mandate, which includes both price stability and "maximum employment," along with the fact that members of the Federal Reserve’s Board of Governors saw deflationary risks in 2008 and 2010.
In contrast, the ECB does not have a dual mandate. Its sole mandate is to maintain price stability. Additionally, the ECB was created in the mold of the modern Bundesbank, which has a very conservative attitude toward loose monetary regimes or anything that could heighten inflationary pressures. Given this background, it is not surprising to us that the current ECB president, Mario Draghi, has denied requests to buy the sovereign debt of troubled euro zone nations in a quantitative easing exercise. With a policy rate of 1.25%, the bank can still provide additional easing by lowering rates.
The ECB has also remained very lax with loans to euro zone commercial banks. It is currently accepting dodgy collateral for loans to these institutions. The bank would need to move its policy rate to near zero before a justification for negative theoretical rates would be called for, in our opinion. At that time, if the ECB were to engage in a quantitative easing exercise, we believe it would specify a limited amount that could be employed to achieve additional monetary stimulus. In our opinion, there would be no yield target for euro zone peripheral bonds — the ECB would not engage in a rescue of a member's bond market as doing so could pose a number of difficult questions. How would it decide which country to rescue? Would it have guarantees of fiscal prudence from the country necessary to justify extreme monetary measures?
Finally, let's consider the position of Germany (Merkel and Bundesbank President Jens Weidmann): All the funding that Germany has provided throughout the crisis to this point has been conditional: (i) the International Monetary Fund-European Union loans to Greece, Ireland, and Portugal have strict requirements that need to be met in order for the recipients to receive each tranche; (ii) Germany’s commitment to the European Financial Stability Facility (EFSF) was strictly limited to just €240 million.
So, while many investors may argue that Germany is playing a dangerous game of “chicken” in preventing the ECB from going “all-in,” we believe Germany sees today’s crisis conditions as an opportunity, offering the greatest chance of achieving fiscal union. (Remember, it was Germany who demanded the inclusion of the Stability Pact in the EU Treaty.) Therefore, even if you dismiss the above analysis of why the ECB has not bent to market demands to go "all-in," we feel it should be remembered that Germany is insisting to the other EU member states that its commitment to a further bailout is conditional on achieving fiscal union.
We acknowledge that calls for extreme action by the ECB mean that market pressures are great, and financial entities and market participants are suffering. We remain committed to our resolve that this is a fragile investment environment, and we believe a conservative positioning is warranted in investment portfolios.
The views expressed were current as of Dec. 6, 2011, and are subject to change at any time.
Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting the fund literature page or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.
IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.
Comments represent the views and opinions of the author(s) regarding the economic conditions referenced herein. Any reproduction of these materials, in whole or in part, or the divulgence of any of the contents thereof, without prior consent of Delaware Investments is prohibited. Certain information contained herein has been obtained from sources that Delaware Investments believes to be reliable as of the date presented; however Delaware Investments cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed.
The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. Delaware Investments has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services and should not be used as the basis for any investment decision. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. Delaware Investments and its affiliates may make investment decisions that are inconsistent with the recommendations or views expressed herein, including for proprietary accounts of Delaware Investments or its affiliates.
The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or funds to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or funds for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions.
Conflicts of Interest: Delaware Investments and its affiliates may have investment advisory or other business relationships with the issuers of securities referenced herein. Delaware Investments and its affiliates, officers, directors and employees may from time to time have long or short positions in and buy or sell securities or financial instruments referenced herein. Delaware Investments affiliates may develop and publish research that is independent of, and different than, the information contained herein. Delaware Investments personnel other than the author(s), such as sales, marketing, and trading personnel, may provide oral or written market commentary or ideas to clients of Delaware Investments or prospects or proprietary investment ideas that differ from the views expressed herein. Additional information regarding actual and potential conflicts of interest is available in Part II of Form ADV for Delaware Management Business Trust.