Barring some kind of grotesque twist, the European Central Bank will announce Thursday that it’s going to start buying the bonds of Eurozone governments in large quantities.
That should be good news for for financial markets, which never turn their noses up at the prospect of free money, but there are a number of reasons why ‘quantitative easing’ may not have the same uplifting effect on the Eurozone economy–let alone the global one–as it did in the U.S.
The biggest difference is political and institutional. While QE had the broadest possible support in the U.S., there are huge political objections to it in Germany, the Eurozone’s largest (and healthiest) economy, as well as a handful of other northern European countries. As such, many fear it could do more to split the currency union than bring it together.
In the five years since the Eurozone debt crisis exploded, German opinion hasn’t really moved much beyond the view that QE will only give lazy and cowardly governments elsewhere an excuse not to make the kind of heroic reforms that Germany did 10 years ago.
“The more they (the ECB) do, the bigger the incentive for governments to do less,” complained Axel Weber, the former Bundesbank head who is now chairman of Swiss bank UBS AG (UBS), told the World Economic Forum in Davos Wednesday.
Lars Feld, an economic adviser to the German government, meanwhile told the mass daily Bild-Zeitung that “without reforms, France and Italy will just carry on crawling around, with negative consequences for our exports.”
Outside Germany, almost everyone–from the IMF to France to China–see deflation as the more pressing risk. The headline rate of inflation fell to -0.2% in December thanks to collapsing oil prices, and unemployment is still running at 11.5% of the workforce.
“Europe is not growing and is on the brink of deflating,” former Treasury Secretary Larry Summers said Tuesday in a speech in London. Top ECB officials openly admit that cheaper oil is only strengthening the impression that the Eurozone is heading into a destructive spiral.
According to leaked reports, the ECB is trying to mitigate German concerns about ‘stealth bailouts’ of other countries by suggesting that the act of buying the bonds should be devolved to the respective 19 national central banks of the Eurozone, and that they should only buy the bonds of their own governments. That way, if a country such as Italy should ever leave the Eurozone, it will only be the Italian central bank that loses money on its bond holdings.
The trouble with that proposal is that it implicitly encourages the belief that the Eurozone can after all break up–which is exactly the reverse of what the ECB was trying to argue when President Mario Draghi promised in 2012 to do “whatever it takes” to keep it together.
Then there is the unfortunate fact that the ECB itself has been arguing for years that QE will be ineffective in the Eurozone because it’s banks, rather than bond markets, that determine credit conditions for households and businesses in the Eurozone. About three-quarters of total financing for the economy goes through that channel, while a quarter goes through the capital markets. The proportions are roughly reversed in the U.S.
Ironically, the ECB appears to be launching QE just as banks are starting to lend, again after years of sitting in a zombie-like trance, unable to make new loans because they were sitting on billions in undeclared losses on real estate, government bonds and so on. The ECB’s quarterly bank lending survey, released Tuesday, showed that both the supply of and demand for credit are clearly turning up.
That much, at least, is good news. The extra money that the ECB is ready to create will now find some willing takers in the real economy. By contrast, Draghi’s promise in the summer to increase the ECB’s balance sheet by 1 trillion euros has fallen flat because banks were either unable to find solvent borrowers, or just used the money to replace other, shorter, loans they’d taken from the ECB.
Regardless of its actual merits, the impact of QE on the U.S. (and U.K. and Japan) has been as much psychological as real, by giving the impression that the authorities were at least fully committed to stopping deflation. And that psychological impact has depended largely on its presentation–on its ability to shock and awe financial markets into believing the situation was under control.
The ECB tomorrow will have to overcome two other challenges on that front. First, there are already huge expectations factored into financial markets: Deutsche Bank chief executive Anshu Jain told Davos that markets have already priced in €500 billion of QE. With the latest leaks suggesting that the main proposal for discussion tomorrow will be for roughly €50 billion a month in bond purchases through the end of 2015–a total of €600 billion–it will take something really big for the markets not to ‘sell the fact’ having ‘bought the rumor’.
Secondly, the ECB will be making its announcement at a time when when markets’ faith in central banks is starting to waver quite badly. After the chaos sparked by the Swiss National Bank last week, Denmark was panicked into an unscheduled rate cut Tuesday, and Canada cut its interest rates Wednesday while keeping its core forecast for inflation unchanged and raising its growth estimate for next year–“a spectacular loss of nerve,” according to ADM ISI economist Marc Ostwald in London.
“The whole mirage of stability that developed-world central banks have sought to foster in the post-crisis era (is) starting to unravel in a rather disorderly fashion,” Ostwald said. “The ECB’s task tomorrow looks ever more unenviable!”