ECB MUST RESIST QUANTITATIVE - EASING SIREN CALL / THE WALL STREET JOURNAL( HIGHLY RECOMMENDED READING )

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MAY 4, 2010, 5:23 P.M. ET.

ECB Must Resist Quantitative-Easing Siren Call .

By RICHARD BARLEY And SIMON NIXON

The European Central Bank has already performed one screeching U-turn, announcing it would accept Greek bonds as collateral even if all major rating agencies downgrade it to junk. Now the market is questioning whether the ECB will be forced to break the final taboo: printing money to buy government bonds directly. That would be a disastrous step, for the ECB, the euro and the euro zone. The central bank should resist it, even if the result is the breakup of the single currency.

ECB President Jean-Claude Trichet said over the weekend there was "absolutely no decision" on buying government bonds—which only served to stoke the speculation. Despite a €110 billion ($145 billion) package for Greece, the market stepped up the pressure on Tuesday, with Portuguese and Spanish bonds hit again. Of course, this may simply reflect execution risk; the market may calm once the package is activated. But if it doesn't, euro-zone policy makers will find themselves desperately short of options. Given the political difficulties in agreeing on the Greek package, it is hard to see the euro zone agreeing on a similar deal for other nations.

Until now, the ECB has supported government-bond markets by offering unlimited liquidity to the banking system at low rates. Banks used some of this liquidity to take advantage of steep government-bond yield curves, providing banks with an apparently risk-free profit and governments with a ready source of demand for their bonds. But if the euro-zone crisis intensifies, banks are unlikely to keep buying bonds from governments perceived to present default risk.

Besides, the ECB would face a major credibility crisis if it started buying government bonds now, since the ECB has already announced it is scaling back its liquidity programs. And unlike the U.S. Federal Reserve and Bank of England's quantitative-easing programs, which were presented as monetary-policy operations designed to ward off deflation, any ECB step down this path would be an unambiguous exercise in debt monetization.

In any case, there are good reasons why the ECB has so far resisted direct quantitative easing. Not only is it prohibited under its mandate, but it would undermine the ECB's independence and the euro zone's separation of monetary and fiscal policy. Any decision by the ECB to buy bonds of certain nations would risk a fiscal transfer over the heads of sovereign powers that would be politically controversial.
Purchases of European government bonds would be the final desperate step in a process that has seen the debt crisis move from subprime U.S. borrowers at the outer reaches of the financial system to its heart in just three years. It would be an admission that the single-currency experiment had failed. If the crisis gets to that point, better to face up to the failure.

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