Wednesday, May 12, 2010

Euro Debt Crisis and Contagion Roundup At Morgan Stanley

Morgan Stanley’s Global Economic Forum has a fantastic roundup of developments in Europe and possible contagion effects around the globe, including East Asia as well as a piece on Malaysia (excerpt):

We think that the impact on Malaysia would be more significant from the perspective of trade linkage rather than capital flows. On the latter, Malaysia's FX reserves are about three times its short-term external debt. This is way above the global adequacy benchmark of one, reducing the currency's vulnerability should capital flows dry up. Moreover, the basic balance surplus (comprising more stable flows such as current account balance and FDI) had been the key contributor to the balance of payments position and FX reserves, rather than portfolio flows. This also further mitigates the impact on domestic liquidity conditions and currency amid a decline in risk appetite. Indeed, Malaysia's exposure to the fiscal debt concerns in Europe would come predominantly via the trade front. As a portion of total exports, ASEAN exporters' exposure levels to Europe demand look fairly similar. About 8.6-11.0% of total ASEAN exports are bound for the EU15. More specifically, 0.5-3.2% of ASEAN total exports are bound for Greece, Italy, Portugal and Spain. However, within ASEAN, we note the high export orientation of Malaysia's economy, with exports of goods standing at 82% of GDP (of which 10.3% is to the EU15). In this regard, Malaysia would thus be the second most exposed (after Singapore) to a slowdown in euro growth and the cascading effects of that on Europe's trade partners.

Note: Since the page link will change depending on updates to GEF, I’ll be updating the hyperlink to the MS page once it gets posted to the GEF archive.

About the only (technical) quibble I have is this line in the article analysing the compromising of the ECB’s independence:

Tonight the ECB decided to take one step further and - in addition to reinstating some of the measures it had already taken during the height of the financial crisis (term funding and USD swap lines) - also open the door to outright purchases of government bonds. These purchases will be sterilised and as such do not constitute quantitative easing, i.e., an expansion of the ECB's balance sheet.  So far, the size of the intervention programme and the details about which debt instruments the ECB is going to buy are not known.

They’re right that sterilised purchases of Eurozone government bonds would not constitute quantitative easing, but they’re wrong that it would not result in an expansion of the ECB’s balance sheet. My understanding of the process goes something like this:

1. Purchase of Euro government bonds through Euros created at the ECB (+ assets, +liabilities)

2. Sterilisation through issuance of ECB bills to drain the excess money created in step 1 (+ assets, + liabilities) – money supply stays constant

3. Offset of Euros created and bought back in step 1 and 2 (- assets, - liabilities)

This means the ECB’s balance sheet will still increase by whatever amount of government bonds it purchases, except that its liabilities will be interest bearing (ECB bills) rather than non-interest bearing (Euros).


Link to the archived page.


  1. Nice pointer on the exact mechanics of monetizing the debt. If Morgan Stanley got that wrong would one be wrong to assume that they don't know what they are talking about.

    (2) Can I sell my Greecian Bonds bought at a steep discount to the ECB at par? Do you have Trichet's number? :-)

  2. (1) Nah, I think it was just a careless mistake. People always equate quantative easing with an expansion in the central bank's balance sheet. Just because you sterilise the intervention doesn't mean it still doesn't happen.

    (2) LOL - you can always try!