VIDEO: The ECB’s bond-buying program explained with bonbons
To understand this bond-buying spree that the European Central Bank is about to embark on, I find it helps to think about candy. Specifically, let’s imagine each country in Europe is a candy shop.
So you have this string of candy shops around Europe. Each sells different kinds of candy — rock candy, peanut brittle, Skittles. But ALL of them sell their own variety of what we’ll call sovereign bonbons. Now in some stores, those sovereign bonbons aren’t selling too well.
So the candy store owners have asked a big investor to help.
The investor thinks this has a simple solution: supply and demand. If he buys up a bunch of the bon bons in say Greece, Spain and Italy, people will see how popular these candies are, and demand for them will go up. That will allow the store owners to charge more.
In return for this favor, the candy store owners have agreed to clean up their shops — not spend too much on things like candy display cases or fancy bonuses for their workers. In other words, tighten up their budgets.
Store employees might even be paid less — although they’ll probably still get the same vacation.
And the investor? Well, he can sell those bon bons if he wants. Or he might hold onto them until they mature.
So to break down the analogy here: the candy stores are European countries. The investor is the ECB. The sovereign bonbons are bonds. And when demand for bonds goes up, interest rates go down — which is what the ECB and the eurozone nations — all want.
But what happens when those bonds mature? If those nations are solvent, the ECB will get paid. Sweet! If they’re not… well, it’ll leave a bad taste in everyone’s mouth.
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