WASHINGTON – Here we go. European Central Bank (ECB) President Mario Draghi launched his own version of QE, or “Quantitative Easing”. The goal of a rather large bond buying program (about 60 billion Euro or $ 68 billion a month) is to lower interest rates, spur more lending and energize the semi-comatose Eurozone economies, (Germany and a few others being the exception).
Well, good luck! Draghi himself in many different occasions urged European Governments to take bold action by reforming bloated welfare states and labor markets, while reducing regulations that suffocate business.
Yes, believe it or not, ultimately one needs new money-making enterprises to grow the economy and add jobs. That is the real deal.
Monetary manipulation alone will not get you very far unless policy changes create a more propitious “business climate”. But Draghi for some reasons felt compelled to act now, even though he knows very well that real economic policy changes will not follow his new monetary manoeuvres.
Monetary easing instead of reforms
Indeed, Europe has not moved and will not move on this needed pro-growth agenda. Given this most unpromising background, it takes an act of faith to believe that even lower interest rates –now already quite low– will trigger a healthy cycle of higher growth within the Eurozone. Does Draghi really believe that his QE will do the trick?
Devalued Euro is good for exporters
Sure enough, this move aimed at increasing liquidity has had the immediate effect to further devalue an already devalued Euro. This is of course good news for all the European companies that export outside the Eurozone. As their goods and services are now cheaper, they are more competitive; and therefore they are likely to get more business.
This is no cure
But the notion that devaluation is a good cure-all for any economic malaise is false. The damage is usually bigger that the gain. Look at Japan. “Abenomics” did more or less the same thing the ECB is beginning now. As a result, the yen took a dive. And, of course, with a lower yen Japanese exporters are doing much better. But everybody else is doing worse, since the cost of imported goods went up.
Right now, Europe benefits from cheap oil. Even when paying with a devalued Euro for oil priced in dollars, the Europeans still benefit from the global oil prices collapse. And this is good news. But everything else will be more expensive.
Easy borrowing will discourage reforms
Furthermore, the unintended negative effect of even lower interest rates is that eternally profligate European Governments now know that they will be able to go deeper into debt at a lower cost. Ironically, while Draghi urges EU Governments to get busy with a credible reform agenda, his polices cause even lower interest rates, and this will make it easier for Rome, Paris or Madrid to get into even more debt. Which is to say that QE will allow this deplorable trend of more spending and more debt to go on a little longer.
Low yields on 10 year bonds
Look, with already depressed interest rates due to monetary easing prior to the launching of Draghi’s QE, we had the absurdity of French 10 year bonds with a 0.70% yield, while Italian 10 year bonds were at 1.56%. Which is to say that French and Italian bonds must be a super safe investment.
Italy must have solid finances
While the US Federal Reserve is also guilty of the same crime of having created and maintained artificially low interest rates, the US 10 year bond has a higher yield of 1.8%. Until very recently it was above 2%. And this is in America, still the world’s largest economy, with a rate of growth of about 3%. But from this interest rates picture we get that French 10 year bonds are so much safer that investors grab them even with less than 1% interest. And Italy’s finances must also be in better shape than America’s. What do you know, with an economy at a stand still, sky-high unemployment and debt now at 130% of GDP, Italian bonds are super safe, and this is reflected in the 1.56% yield.
Monetary manipulation produces distortions
When Central Banks create these types of market distortions through monetary manipulation, so that there is no longer any honest valuation and “price discovery” in something as basic as government bonds, it is hard to believe that things will get better in the real economy on account of another big helping of manipulation, via QE.
ECB President Draghi is simply adding more “feel good medicine” to a Eurozone public debt market in which bond prices are no longer a reflection of real risk. This is really dangerous.
And now the ECB will make a bad situation even worse. Because of even lower interest rates caused by QE, Eurozone governments will mistakenly believe that their financial wiggle room really improved. Feeling no real pressure to get their economic and fiscal house in order, they will yet again postpone any serious pro-market, pro-business reform effort. No serious reform, no chance to have any appreciable new growth.
No welfare state reform
In the meantime, with so many restless segments of society demanding pensions, entitlements, and other benefits, European politicians elected to safeguard clearly unaffordable welfare states will continue to spend money they do not have, counting on the ECB to buy their bonds, so that they will be able to keep borrowing at ridiculously low interest.
I understand that President Mario Draghi is doing the best he can in extremely unfavorable circumstances. But anybody believing that this ECB-managed QE is the real deal that –all by itself– will trigger a new era of growth within the Eurozone is a fool. The Eurozone needs good economic fundamentals, and QE is not one of them.