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Is 1.2 Trillion Euros The Right Answer To The Wrong Question?


Good News Or Bad News?

Once upon a time something good happened for Europe.  The price of oil went down dramatically.  When the oil price halved in the last months of 2014, there was no way for the European Central Bank (ECB) to fulfill its mandate of keeping price growth close to 2 percent a year.  The ECB painted itself into a corner by targeting headline inflation, not core inflation, which excludes food and energy.  Left with no choice, the ECB announced on 22nd January 2015 that it would begin printing digital money in large quantities, ie start Quantitative Easing or QE in the near future.  Contrary to popular myth, QE doesn't fight 'deflation', it rather causes it by keeping zombie banks alive.  Why? Quantitative easing simply buries money in commercial bank vaults, by bolstering their balance sheets, when it is cash in circulation that is desperately needed.  

What Can QE Achieve?

What does the ECB's 60 billion euros per month of bond buying, or 1.2 trillion euros in total between March 2015 and September 2016, hope to achieve?  QE from the ECB won't accelerate the euro zone economy in any significant way.  The ECB initiative risks delivering too little, too late, leaving the bloc struggling to grow and afflicted by deflation.  Euro zone QE has already come too late to lift the region off the reefs on its own.  The most dangerous challenge for the euro and the European project is not deflation but the policy of 'real', as opposed to 'perceived', austerity, which is killing growth and employment.  Further, this spawns fringe political parties and movements that seek to exit from Europe altogether.

Right Answer, Wrong Question?

So, why is euro QE the right answer to the wrong question?  The right question is, how can Europe rebalance internally?  We should open our eyes to the inherent failures of the euro zone, which is likely to produce a crisis regularly for as long as it fails to recognise the differing needs of struggling economies within its borders.  The euro zone cannot really cope with asymmetric shocks, like a collapse in the price of oil and gas.  Indeed it tends to design and implement policies that exacerbate those shocks. 

Is Deflation A Threat?

Deflation is possibly one of the most abused terms in economic policy discussions at present. There is perhaps no real threat from deflation as asset prices continue to rise. The Bank for International Settlement in Basel has made it clear in a study of over 150 years that a mild decline in prices is no problem for real GDP growth, and especially within the euro zone. The only reason why we may have a negative inflation rate is the decline in oil and commodity prices, but that decline is good for most of the economies in the euro zone.

The Big Elephant

All these calculations are perhaps comparatively minor to the consequences of a win of the anti-bailout party in the upcoming Greek elections at the end of January.  Is this the baby elephant troubling the big elephant in the room? Or the little g troubling the Big G?  Whatever the outcome, the euro area needs to sit down and re-build the foundations by addressing competitiveness, especially by making structural changes to labour markets and encouraging entrepreneurship.  Otherwise this crisis will drag on for years to come leading, not just to a lost decade, but perhaps more.  

Key Questions

What if Greece leaves the euro zone? Would it cause a cascading crisis in confidence for the euro on the world markets?  With only a few days until an election in Greece, what could or should businesses do to prepare for further volatility in regard to the euro?

What are your thoughts, observations and views?  We are keen to listen and to learn.  Please add your comments below. 

DK Matai

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All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Comments (2) -

  • E Marshall

    23/01/2015 00:51:05 |

    One is reminded of the 18th century economist John Law, who encouraged the French government to print money on the basis that it would stimulate the bankers and others to invest in industry. Instead they kept the money for themselves. John Law was hounded out of France as the economic situation deteriorated even further. Will history repeat itself with the ECB money printing and expectations echoing those of John Law 300 years ago?Can we believe that fundamental truths in terms of human economic behaviour have changed?

  • Stephen Clothier

    23/01/2015 07:34:37 |

    It is abundantly clear from the above analysis, and those elsewhere, that there has to be a political redesign within Eurozone, an EU 3.0. Any number of broad fiscal or specific economic bailouts will not solve the problem which is a political one of emperor's clothes: the political class has long been behaving as if Europe is already a homogeneous entity, with edicts from "what an acceptable EU sausage is" to how much deficit limit all countries must respect. This is tantamount to setting the club rules before there are any real members - the single currency probably being the most visible offender, but total uncontrolled (or rather "controlled" on an EU scale) freedom of movement being close behind.

    But for a political EU 3.0  the political class must be forced into admitting there is a problem with EU 2.0, and, although some national leaders (e.g. UK) have been forced into admitting this due to democratic pressure at home, this is a long way off. Worse, the situation is decomposing onto those who believe 3.0 must be a single nation, and those who see it as a more loose grouping of individual nations than at present.  I do not believe the political class will be able to manage this divergence, and so we need to wait until the inevitable and possibly violent breakup - at least of some member states, before anything realistically happens.

    I have seen this in Switzerland (an EU member by all except title), where the people (marginally) voted for a stop to uncontrolled movement, but the political class are making no reals signs of adhering to their national constitutional requirement to fulfill this wish, are considering a re-vote (and even considering the general curbing of "Swiss Direct Democracy" in the future). This is reminiscent of the way in which the EU was crystallized in the first place.

    I will probably slightly misquote Einstein if I say "We cannot solve this problem at the same level we caused it".

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