• The ECB is buying sovereign bonds, to help out EU nations who are running a deficit they are having trouble financing at market rates.


• By doing so, all else being equal, they are creating money out of nothing.

Well, that's what the ECB believes. Trouble is, the ECB doesn't understand what money is and how it works.

The second that the ECB accepted these sovereign bonds as collateral at the discount window, they became money. New money is being created when states run deficits (as long as their bonds are acceptable collateral at the discount window), not when the ECB happens to get off its ass and fix the interest rate on those bonds.

So what the ECB is doing here is exchanging bonds (which is money, since you can post it as collateral at the discount window) for ECB reserves (which is money because it is legal tender). This neither adds to nor diminishes the liquidity in the European interbank market. The banks want to make that transaction not to increase their liquidity (which it doesn't), but because it enables them to go from paying interest at the discount window to being paid interest on ECB reserves. From the bank's point of view, there's nothing not to like here.

The problem is that the ECB believes that the above operation increases available liquidity, when all it actually does is grant a subsidy to the banks. So the ECB tries to draw out the same amount of liquidity from the interbank market that they believe they put in. Unfortunately, while the liquidity they put in is a figment of their gold-standard delusions, the method they use to drain liquidity results in a very much real diminution of interbank liquidity.

The more fundamental problem is that the ECB tries to control interest rates by offering and withdrawing liquidity. There were excellent operational reasons for doing things that way under the gold standard, but under a fiat currency it is a monumentally moronic way of running a monetary system. Because under a fiat currency, the ECB can always simply dictate interbank rates and let the amount of liquidity in the system sort itself out.

(The reason it can't do that under a gold standard is that there is an upper limit to the amount of liquidity that can be sustained in a gold standard system without creating a window of opportunity for a speculative run on the central bank. But under a fiat currency it is not usually possible to stage a run on the central bank.)

- Jake

Friends come and go. Enemies accumulate.