The European Central Bank took no decisive action last Thursday either to lower Eurozone interest rates or launch its own programme of “quantitative easing”. It was made clear, though, that the ECB may soon follow the US Federal Reserve and Bank of England by firing up Frankfurt’s virtual printing press and creating, ex nihilo, hundreds of billions of euros.
The council was “unanimous”, said ECB boss Mario Draghi, a hint of steel entering his voice, in its commitment to “unconventional instruments”. In case that wasn’t crystal, he spelt it out. “All instruments within our mandate are part of this statement,” he told the world. “There was, in fact, during the discussion we had today, a discussion of QE”.
The official line is that the ECB is considering joining the mass money-printing club because of fears about deflation. In March, Eurozone inflation was indeed just 0.5pc, on official measures. The underlying motivation for Euro-QE, though, is rather different. Financial markets denizens know this, but few are prepared to say it.
Massive losses continue to smolder on European bank balance sheets. It was the acute danger of clapped-out banks dragging their host governments into bankruptcy that caused systemic panic across Eurozone sovereign bonds markets, threatening the entire single currency project, during the summer of both 2011 and, particularly, 2012.
Such alarm bells led to Draghi’s “whatever it takes” speech – a promise the ECB was ready to buy up Eurozone government bonds under a scheme called Outright Monetary Transactions. That’s yet to happen and may even be illegal. Various European courts are still thinking about it, having issued a series of technical verdicts kicking the issue into the long grass. But just the breaking of the taboo, the notion the ECB could come to the rescue and hose down a bad situation with printed money, has been enough, for now, to spread calm.
Despite the OMT bluster, the underlying problem remains. Numerous Eurozone banks are busted – not only in profligate “Club Med” nations like France and Italy but Germany too. Such banks, though, are too politically-connected to be allowed to fail.
That’s one reason the Eurozone elite wants QE – so out-of-thin-air wonga can by used to buy dodgy bank loans, allowing smooth bankers to avoid the realities of their mistakes. Such purchases would be the focus of Euro-QE, rather than sovereign debt, allowing OMT to remain untested. A dose of ECB funny-money would certainly work wonders, polishing-up Eurozone bank balance sheets prior to official “stress tests” scheduled for October.
Another reason the ECB wants QE is that both the US and UK have printed money like crazy and, as a result, the dollar and pound have fallen against the euro, making Eurozone exports less competitive. Polite society talks about “saving Europe from deflation”, but QE is really about saving rancid banks from themselves, while trying to provoke beggar-thy-neighbour-style euro depreciation.
As such, Draghi’s display of QE ankle on Thursday sent the single currency to a monthly low against the dollar. But the euro is still uncomfortably strong at around $1.37, compared to around $1.20 back in mid-2012 at the height of the Eurozone’s systemic troubles. And that’s compounded the problems of “periphery” countries like Greece and Spain, making their exports more expensive.
Since mid-2008, the Federal Reserve has expanded its balance sheet four-fold. The Bank of England has practiced QE on a similarly larcenous scale. In truth, the Eurozone has been doing plenty of QE too, the ECB’s balance sheet having surged from around €1,700bn in 2009 to over €3,000bn three years later, before partially falling back. But so sensitive is the German public about money-printing and its eventual inflationary impact, that Euro-QE has been cleverly masked. Various schemes, hidden behind technical names such as ESM and Target-2, have expanded the Eurozone’s money supply in a way the currency markets understand, even if ordinary voters don’t.
So far, the Anglo-Saxon world’s overt QE has out-printed the Eurozone’s sotto voce variant – so the currency advantage has been ours. Now, official determination to get the euro back over $1.40 is so strong that even Berlin is signaling it might back explicit QE.
Even before Draghi spoke, the US moved to maintain the upper hand in terms of keeping the dollar relatively weak. On Tuesday, Fed Chair Janet Yellen signaled that America’s central bank would continue to provide “extraordinary support for some time to come”, pulling back from previous remarks that interest rates could rise once US QE “tapering” finishes towards the end of this year.
If the ECB does go for explicit money-printing, I wouldn’t be surprised if the Fed found an excuse to slow down its QE withdrawal program, extending “extraordinary measures” further.
Concerns about QE came to the fore last week, during a debate I chaired at London’s Cass Business School. The event was held to mark the publication of “Emerging Markets in an Upside Down World,” a new book by Jerome Booth, the City financier.
While Booth accepts the early use of QE to fend-off a systemic post-Lehman disaster, he’s concerned the policy was expanded way beyond original announcements – from £50bn to £375bn in the UK’s case – while Western banks remain systemically risky. “QE shouldn’t be interpreted, as it often is, as a way of pump-priming the whole economy,” he said. “It’s like putting a blanket over a dead body, which keeps the flies away but doesn’t solve the problem. We’re now using bigger and bigger blankets”.
Lord Lawson, also on the panel, was similarly critical. “Western Policymakers now know they need to get out of QE but they don’t quite know how,” said the Former Chancellor. “So they’re still thrashing around”.
It’s worth recording that during the Cass debate, Lord Lawson was even more concerned about the “fundamental problem” that continues to hang over the Western banking system than he was about QE after-effects.
“I don’t believe our problems can be solved by a ring-fence between investment banking and commercial banking,” he said, referring to the Vickers Commission recommendations, due to be implemented by 2019.
“The Vickers model of corporate governance is one that has never worked anywhere in the world, and I don’t believe it is workable,” said Lord Lawson. “And I don’t know any senior banker who believes privately that this model is workable”.
As a leading member of the Parliamentary Banking Commission, Lord Lawson’s remarks carry enormous political weight, and are likely to re-open the UK’s debate about the need to impose a Glass-Steagall split between retail-commercial banks, where firms and households store their deposits, and investment banks, which take big risks.
“There is a fundamental problem if you bring investment banking, with its fundamentally different culture, into high street banking,” Lord Lawson continued, highlighting that if City traders and their managers know they’re betting with ordinary deposits, and can cause systemic havoc, they’re covered by an implicit taxpayer-backed guarantee.
“The fear of failure has been removed from our banking system,” Lord Lawson boomed. “And unless banks are allowed to fail, then we are going to have problems time and time again”.
Calling for “a more radical approach”, he renewed his long-standing call for the UK to implement a full Glass-Steagall separation of investment and commercial banks. “Regulators will never succeed in regulating the universal banks, never,” he warned. “It is foolish to think that you can”.