“At the end fiat money returns to its inner value – zero.” – Voltaire
“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” – Mario Draghi July 26, 2012
On July 26, 2012, European Central Bank (ECB) President Mario Draghi essentially guaranteed the ECB would not allow the markets to cripple the Euro region. This shot across the bow finally remedied the instability caused by the sovereign debt crisis. The markets quickly reversed the damaging trends and uncertainty that had plagued the Euro-zone for months.
Draghi’s statement essentially boiled down to a promise that the ECB would print unlimited amounts of money to stop the “harmful” will of investors.
Fiat currency, be it dollars, euros, yen, or any other major currency today, are backed by confidence in the government, its ability to tax and the status of its economy. Importantly, however, it is also largely based on the trust and confidence in the central bank that issues those notes. If Draghi did not have the market’s trust and confidence, his statement would have been ignored, and there is no telling what might have happened to Greece or the Euro for that matter.
In September 2016, the Bank of Japan (BOJ) introduced Quantitative and Qualitative Easing (QQE) with Yield Curve Control. The new policy framework aimed to strengthen the effects of monetary easing by controlling short-term and long-term interest rates through market operations. The announcement also introduced an “inflation overshooting commitment” with the BOJ committed to expanding the monetary base until the year-over-year inflation rate “exceeds and remains above the 2 percent target in a stable manner.” Essentially, the BOJ pulled a “Draghi” and promised to do “whatever it takes” to ensure interest rates did not rise more than they wanted.
Recently, the BOJ amended the 2016 statement because bond investors were increasingly testing the central bank’s resolve. We are not claiming this just yet, but if the BOJ is losing the trust and confidence of investors, they could be the first domino in a long line that will change the markets drastically.