The European Central Bank is expected to unveil its version of quantitative easing this week, as Europe makes it latest attempt to stave off deflation and recession. The convoluted nature of the eurozone, however, will complicate and potentially compromise the structure and impact of the ECB’s actions.
Even before the ECB has unveiled what is expected to be a €500 billion-plus sovereign bond-buying program, there have been some unintended and quite dramatic consequences.
The Swiss National Bank’s decision to unpeg the Swiss franc from the euro, which was influenced at least partly by the expectation that ECB was about to launch QE in Europe, caused chaos in financial markets last week and saw the euro fall to its lowest levels for more than a decade.
It doesn’t, however, appear to have achieved its primary purpose, which was to arrest or at least slow the flow of funds fleeing the euro for the traditional safe haven of the Swiss franc. Capital is scrambling to exit the euro in anticipation of the QE program.
With the US having ended its bond and mortgage-buying last October and an expectation that it will begin increasing official interest rates sometime this year, a European QE program will exaggerate the extent of the divergence between the developed world’s two largest economic blocs, which could generate more unintended consequences than those spawned by the abrupt Swiss-induced implosion in the euro last week.
Already a number of currency traders have failed and there would be significant losses within hedge funds that had made apparently one-way bets on the SNB maintaining its cap on the SFr/euro exchange rate.
An ECB QE program will be more difficult to construct and almost inevitably less effective than the US Federal Reserve board’s version of QE (and there has been a significant debate about the effectiveness or otherwise of that program).
Unlike the US, the eurozone isn’t a political and fiscal union. The only thing its member states truly share is a common currency and monetary policy, beneath which lies economies as disparate as Germany and Greece.
The need to design a QE program that can both navigate the political and economic differences within Europe almost inevitably means it will involve compromises, adding to the doubts over whether it can make a meaningful difference to the economic condition of the eurozone.
The ECB isn’t helped by the reality that Europe’s corporate bond markets are under-developed relative to those in the US, where the Fed’s program was able to directly influence interest rates on corporate debt. In Europe banks are the major source of funding for corporate band commercial entities and Europe’s banking sector isn’t in a particularly robust state.
Even if the ECB floods the eurozone’s financial system with cheap money, there is no guarantee that it will flow through to increased lending.
In the US banks and corporates de-leveraged and built up their liquidity thanks to the Fed’s program, and hedge funds and other risk-takers used their access to trillions of dollars of cheap funding to search for returns from increasingly exotic risks around the globe. But it didn’t generate a lending spree by banks.
The ECB also has to devise a package that will, if not win the enthusiastic support of Germany, with its visceral antipathy to money-printing and the notion that the industrious and thrifty Germans should effectively transfer wealth to the indolent and profligate south Europeans, at least mute that dissent.
There’s also the added complication (and a live focus for Germany’s concerns (provided by the prospect that the anti-austerity Syriza party, which wants to restructure Greece’s sovereign debt, might win the Greek election.
The prospect of the ECB buying Greek bonds, directly or indirectly, and then seeing them restructured is unpalatable to a number of the eurozone members.
That’s why there have been reports that the ECB program will force national central banks, rather than the eurozone collectively, to execute the QE buying and to incur any losses on their sovereign debt in the event of a default.
That’s essentially spin to appease the Germans and their aversion to risk and loss-sharing. If there is a sovereign debt default either the rest of Europe will have to bail out that country or force it to leave the eurozone. In either event, the rest of the eurozone would end up exposed to the losses.
Assuming the ECB does push the button the program this week, or at least announces a timetable for a QE program, it will be an admission of desperation.
More than six years after the crisis Europe is sliding back into recession, hasn’t confronted the structural deficiencies in the eurozone exposed by the crisis, hasn’t addressed the structural issues within many of its member economies and is confronted by unpalatable high levels of unemployment and rising social tensions. QE is the final card the ECB can turn over.
The euro has already fallen very significantly and sovereign debt yields are remarkably low, thanks to the flood of cheap money created by the QE programs in the US and Japan. Spain can borrow more cheaply than the US Treasury!
Thus there is a real question mark over whether an ECB QE program will have a materially positive effect and spark the spending and investment necessary to generate some growth.
It may, however, further distort risk and value signals already warped and muted by the monetary policies pursued by the major economies since the crisis. Unconventional monetary policies produce unanticipated consequences, some of them quite harmful and destabilising.