“There needs to be a certain credibility,” opined Mario Draghi, President of the European Central Bank, as he launched outright Eurozone quantitative easing last Thursday. “Today, we’re showing that such credibility is deserved”. When used by an economist, “credibility” is indeed a very important word. But I’m afraid I take issue with Signor Draghi’s usage.
When I began studying the dismal science – some 30 years ago, I’ve just realised with anguish – central bankers gained “credibility” by implementing policies which were tough over the short-term but ultimately constructive for the longer-term health of the economy.
The Bundesbank earned genuine credibility during the 1960s and 70s, by using tight monetary policy to banish the horrors of Weimer hyperinflation to history and turning the mark into the world’s most respected major currency. Those actions, while painful and often criticised at the time, laid the foundations of Germany’s modern prosperity, helping transform a war-torn nation into a manufacturing powerhouse.
The Federal Reserve, also, won its credibility spurs in the early 1980s, as Chairman Paul Volcker raised interest rates steadily to rein-in price pressures. This was harsh, but necessary, rescuing the US from its 1970s stagflation malaise, after misguided Keynesian government advisors, ever willing to tell politicians they can borrow and spend their way out of recession, had caused a high-inflation-and-high-unemployment mess.
Congress screamed at Volcker and various newspaper sages went nuts. Yet, rightly, he ignored his popularity ratings. Like a proper grown-up, this New Jersey Lutheran did what needed to be done, so eventually convinced the markets America was good for its debts and if you bought US Treasury bills, the dollar wouldn’t be unduly debased, cutting the value of what you are owed. Again, having been tough in the name of long-term gain, the US then enjoyed a prolonged period of low borrowing costs, economic stability and rising investment.
Mario Draghi, in contrast, and despite his use of the word, has just enacted a policy that is the precise opposite of what it means for a central bank to be “credible”. Euro-QE feels good now but, in the long-term is deeply counter-productive. Far from lowering the chances of a future financial crisis, as Volcker did, and legendary Bundesbank Presidents Karl Klasen and Otmar Emminger before him, Draghi’s actions have actually made another Lehman-style market meltdown more likely.
Ever since his “whatever it takes” speech of mid-2012, we’ve been told the ECB will soon follow the present day Fed and the Bank of England by hosing down the moribund Eurozone economy with printed money. That’s kept financial markets upbeat, as shares have soared and bond yields fallen on Draghi’s continued hints that, despite German opposition, he’ll soon be wielding his monetary bazooka, using balances created ex nihiloeffectively to refinance banks and buy up government bonds.
The ECB President’s actions have created such an expectation, and hype in the markets, that any failure by him to deliver what he said he would deliver last week could have sparked a nasty crash, as shares plunged and bond yields spiked with vengeance as traders realised they’d been duped.
Had Draghi stood up and said “Actually, the Germans said nein”, it is no exaggeration that the government bonds of cash-strapped eurozone “periphery” nations could have gone haywire, perhaps even leading to Greece crashing out of the single currency – and ahead of today’s knife-edge Greek election, in which vehemently anti-European parties, as well as some pretty weird nationalist outfits, are already set to do well.
So, Draghi has shown “credibility” of sorts. But it’s the credibility not of a grown-up central banker – someone who sets out to be independent, take on the politicians and temper their short-termist proclivities, doing what’s right in the long-term rather than what various vested interests want today. Draghi’s credibility, instead, is the credibility of a mewling infant who wants a second helping of ice cream and wants it now.
A spoilt child sits at the kitchen table, displaying a look that signals a tantrum is imminent. Piercing, nerve-jangling screams will be emitted – so loud that the neighbours will hear – unless more ice cream is forthcoming. The exhausted parent hesitates, knowing that yet another bowl of sugar and fat is bad for the child’s health, mindful that giving in – again – encourages further demands and makes no sense in the long-run. Yet the threat is “credible” – the parent is all too aware the screams will be ghastly and, unless the bowl is refilled, the spoilt child won’t hesitate to raise the roof.
For over two years, arch manipulator Draghi has talked up the markets. He is credible not in that he’s delivered economic policy that makes sense, and will make life better for the greatest possible number of hard-working families and their children. His so-called credibility stems from the fact that his political trickery has come off, and the ECB has now been reluctantly permitted by Germany, the Eurozone’s paymaster-in-chief, to enact a massive monetary stimulus. As a result, the region’s still debt-soaked banking sector will enjoy further bail-outs and weak-willed politicians will keep borrowing and spending willy-nilly, so avoiding the genuine structural reforms that many European nations so desperately need.
Working together with political leaders from France, Italy, Spain and other “Latin” Eurozone countries, Draghi has created a situation in which the short-term dangers of withholding the extra ice cream, and blocking Euro-QE, have simply become too great. I don’t think that makes him “credible” as a central banker. I think that makes him a stooge.
The ECB is to flood the Eurozone with at least €1,100bn (£825bn) of newly-created money, we now know, much of which will then be used mostly to purchase government bonds. News that Draghi will, from March, be buying €60bn a month of private and public debt (but mostly public, wink) saw Eurozone stock indices rise to a seven-year high. Yet the rally was rather muted, seeing as the news was already “priced in”. The real market action would have happened, after all, had Draghi not announced Euro-QE.
QE is designed to tackle deflation, we’re told. That’s nothing but a semi-intellectual alibi for a policy that, while it might please those with fat share portfolios, sets up the Eurozone for a crash in which, as usual, ordinary firms and households will suffer the most. Strip out the impact of lower oil prices, and eurozone inflation was positive in December. Yes, we’re below the ECB’s 2pc target, but that’s not due to a lack of printed money. It’s because the Eurozone economy has stalled, with labour markets silted-up by regulation and a still zombiefied banking sector lending far too little to creditworthy firms and households, so strangling aspiration and commerce.
Euro-QE won’t “ease the credit channel” and boost bank lending. The banks will just re-deposit the money they get for selling bonds to the ECB back at the central bank. As such, one of the policy’s main aims is to make bombed-out banks look solvent by boosting their reserves, just as it has been in the UK and US.
Draghi’s actions will, though, weaken the euro – as Eurozone leaders, mindful that Japan has just launched another dose of QE, look to fight back in the “currency wars”. The world’s leading economies are now competing less on the quality of what they produce, than on the speed with which they can depreciate their currencies. That’s the unfortunate truth.
“Super Mario”, they call him. “Supine Mario”, more like. The history of central banking shows that credibility is hard-earned and quickly and easily lost. And Mario Draghi has none.