It’s all about the V-word, apparently. That’s a nod not to Winston Churchill, but a rather different character – namely Mario Draghi, President of the European Central Bank. It would appear a eurozone quantitative easing program running to €1,100bn (£795bn) isn’t enough. Having churned-out €60bn of virtually-printed money a month since March, and committed to maintaining that pace until September 2016, Draghi has now signaled there’s likely to be even more.
“The degree of monetary policy accommodation will need to be re-examined at our December meeting,” he said last week, following the latest gathering of the central bank’s Governing Council in Malta. The “size, duration or composition” of eurozone QE could be adjusted, Draghi continued, with the monthly amounts getting bigger or the schedule extending into 2017 and beyond.
Alternatively, or even in addition, the ECB could use credits created ex nihilo to extend its bond-buying to some of the more ropey corporate bonds otherwise burning holes in the balance sheets of various eurozone banks.
“We’re open to a whole menu of monetary policy instruments,” Draghi continued, indicating that further interest rate cuts were also now on the table. No matter that the benchmark rate is 0.05pc, with the deposit rate at minus 0.2pc – both record lows. No matter that the ECB has only recently said such rates were already at “their lower bound”.
Then, as traders held their collective breath, Draghi delivered hiscoup de grace, declaring that the ECB is now “vigilant”. That was it, the magic V-word, the signal that has previously pointed to definite policy action to come. And, on that utterance, across the entire continent – with absolutely no regard to actual macroeconomic or company news, or any other kind of information that would, under normal circumstances, influence financial markets – stocks and bonds dutifully rallied.
The Europe-wide Stoxx600 share index surged after Draghi’s oral intervention, closing 2pc up. Italian and Spanish benchmark 10-year yields dropped to their lowest levels since April, with the shorter 2-year German sovereign bond hitting an all-time low of minus 0.32pc. The euro itself, on the prospect of even greater money-printing, shed a whopping 1.7pc against the dollar – a big win for the ECB given the implied boost to Eurozone exports.
As a result, Draghi is now being hailed, once again, as a rhetorical wizard, a veritable horse-whisperer among central bankers. Back in mid-2012, when the single currency was imploding, the smooth-talking Italian proclaimed that the ECB would do “whatever it takes” to save the euro. Bond vigilantes retreated, the markets were calmed and the eurocrisis was “solved”. Since then, at regular intervals, Draghi has committed the ECB to fulfilling, if needs be, the pledged Outright Market Transactions programme, a more sustained form of central bank sovereign bond-buying, never yet formally used.
So the ECB supremo has not only glued the single currency together again, putting the great European project back on track by dint of artificial balance sheet expansion. He’s also delivered to Europe’s political and financial classes an asset price rally that’s kept various grossly mismanaged banks afloat and allowed governments to continue with heavy borrowing, despite having nothing – at all – to do with the eurozone’s economic facts on the ground. And now, with a renewed rhetorical flourish, ahead of yet another round of stock-and-bond pumping, Draghi has, in the machismo words of the trading floor, “re-loaded his big bazooka”.
How should a rational person respond to all this? What are we to make of the fact that, across the Western world, financial asset prices now appear to be driven, in the absence of big shocks, largely by the promises of central bankers further to extend, sooner or later, what have become known as “extraordinary monetary measures”?
The first thing is to understand what is actually happening – and why. The ECB, like the Federal Reserve and the Bank of England before it, goes to great lengths to maintain the myth that it is only rolling-out ever more QE in a bid to “meet our inflation mandate”.
Yes, annual inflation across the Eurozone was negative in September 2015, at minus 0.1pc, down from 0.1pc the month before – and a long way from the 2pc target. But that’s mainly because oil prices are some 50pc lower than they were a year ago, and the United Nation’s FAO food price index is 20pc down on September 2014. Strip out those entirely cyclical commodity components and eurozone inflation was positive last month – at close to 1pc.
The threat of “deflation” is often wielded, not just in the Eurozone but across the Western world, as an alibi for politicians and central bankers to keep “extending and pretending” with ever more QE. As the commodity cycle shifts back, and the price drop falls out of the inflation numbers, other reasons to keep on printing will no doubt be cited – be it “turmoil in emerging markets” (already being lined up) or yet another destabilising row between Congress and the White House over the America’s federal borrowing limit (also coming into view).
A major motivation for ever more QE, apart from keeping the asset price rally going, and pushing further into the future the inevitable market tantrum when the sugar-rush (and the prospect of future sugar rushes) finally ends, is to bear down on domestic currencies. The leading central banks involved (be they based in Frankfurt or Washington, London, Tokyo or Beijing) are trying to protect themselves in an largely unspoken, yet on-going currency war.
Growth in the emerging markets has slowed, of course, not least in China – in part due to the beginnings of a necessary and natural shift from investment- to consumer-focussed economics. Sales of goods and services to such countries now account for 25pc of eurozone exports, and almost 35pc in Germany. Faced with a still-fragile banking sector, the eurozone authorities have sprayed-around a great deal of QE money – and that will continue. Given moribund domestic growth, also, the ECB wants to gain competitive ground against the dollar – which means, for now at least, doing more QE than the Fed.
In the end, though, the Fed will decide. If America’s central bank does finally raise rates for the first time since 2006 in early December, as expected, the dollar will get firmer, with the euro falling. That would make it less likely we’ll see additional eurozone QE, beyond the remaining €680bn of the announced programme still to come.
In my view, though, the Fed won’t put up rates. What will happen instead, on some pretext of another, is yet another large dollop of US money-printing, to be known as QE4. As the euro rises, the ECB will then have to respond, exploiting Draghi’s latest V-word preparatory work to extend Frankfurt’s QE programme to 2018 or even beyond. Given the UK’s woeful export performance, and our massive trade deficit, where will that then leave the Bank of England? The Old Lady of Threadneedle Street has never ruled-out more QE.
People talk about currency wars between the West and the emerging markets. Far more serious to my mind, and potentially explosive, are the related intra-Western struggles. QE-to-infinity is pumping up equity and bond markets, blowing an even bigger bubble than that which led to the Lehman collapse – and there’s little sign of a convincing exit strategy. With the best will in the world, it’s hard to imagine this seemingly endless monetary expansion will end well.
“Never run away from anything,” said Churchill. “Never!” Western policy-makers, though, and much of the commentariat, those lauding “Mario’s big bazooka”, are running away – from the screaming dangers of yet more QE.