– Euroland will pay for this monetary madness (Telegraph, Mar 1, 2012):
When something looks dangerous, it generally is. And few things look quite so high-wire right now as the European Central Bank’s efforts to hold the euro together by flooding the banking system with free money.
This week, the ECB injected a further 529.5 billion euros via “long-term refinancing operations”, or LTROs, bringing the tally to more than 1 trillion euros.
When Mario Draghi, the new ECB president, embarked on the programme shortly before Christmas, it was hailed as a masterstroke which had saved the eurozone from financial and economic calamity. Even the Jeremiahs of Germany’s Bundesbank, proud keepers of the sacred flame of monetary conservatism, were stunned into grudging acquiescence by the evident seriousness of the crisis. But now the doubts are beginning to set in, and with good reason.
The measures adopted are so extreme that it is no longer possible to know where they might lead, or what their eventual consequences might be. There is no precedent or road map for this kind of thing. All we do know is that they fail to provide any kind of lasting solution to the single currency’s underlying difficulties, which are still largely unrecognised and unaddressed. If Draghi’s intention was to buy time, it’s not being well used.
It might be argued, of course, that a sticking-plaster solution is better than no solution. And isn’t the ECB only following – if belatedly – the trail blazed by the Bank of England and the US Federal Reserve with their quantitative easing? If our monetary activism can be justified, it’s hard to argue that the ECB’s cannot.
Up to a point, this is correct. What all these programmes try to do is stop the contraction of the money supply threatened by very rapid deleveraging in the banking sector. As banks shrink their balance sheets, by writing off bad debts or refusing credit, the supply of money also shrinks. If unaddressed, this will cause economic collapse, as during the Great Depression.
Yet the particular constraints within the eurozone make the ECB’s efforts somewhat different from Britain’s or America’s. Much of the Mediterranean rim is already in a depression, with disastrous levels of unemployment, contracting output, and a collapsing money supply. What was going on prior to the first tranche of LTROs was a banking run similar to that which culminated in the collapse of Lehman Brothers, as money was withdrawn from the troubled periphery and redeposited in the more solvent core.
The ECB’s actions have succeeded in easing these difficulties, and removing the immediate threat of cascading insolvency throughout the European banking system. But they have also stored up big problems for the future. To get the cheap funding, banks must lodge their better-quality collateral with the ECB. The effect is to dilute the quality of their remaining balance sheet, making it even more difficult to get funding from the markets as normal. As a result, European banking is becoming ever more dependent on ECB life-support, with no obvious way off it.
The rules prevent the ECB from the direct buying of government bonds that the Bank of England practises via quantitative easing. To get money into the system, it is therefore obliged to resort to this roundabout, backdoor approach. Its cheap funding is in part used by the banks to buy high-yield sovereign bonds issued in the periphery, which in turn eases the immediate fiscal crisis. Yet it’s hard to see how getting European banks to buy bonds from potentially insolvent countries is going to restore confidence in the system as a whole.
The ECB’s activities also create huge potential liabilities for the more solvent countries that ultimately – through their national central banks – provide the funding for all this. What is in essence happening is that the banking risks of the European periphery are being progressively foisted onto the taxpayers of the more solvent core. Once people in those countries actually realise what’s going on, they’re going to hit the roof.
Taken as a whole, the sophistry of the process is breathtaking. The ECB is in effect being used as a mechanism for making fiscal transfers between countries, which can only legitimately be agreed by elected governments. To save the politicians’ blushes, the transfers are being executed via an unelected monetary authority. It’s another example of how legal and democratic niceties seem to have been abandoned in the scramble to save the euro. The fiscal compact, almost certainly illegal within the wider framework of the European Union, is not the paving stone to fiscal federalism it pretends to be, but a form of economic dictatorship which seems to condemn much of the periphery to permanent depression.
The more policy-makers dig, the deeper into the mire they sink. In despair, one of the most famous names in British finance, the Prudential, is threatening to redomicile to Asia to escape the latest madcap piece of insurance regulation to come out of Brussels: it would wipe 20 per cent off the value of many pensions, stop insurers investing in banks and infrastructure, and would have resulted in the entire sector being declared insolvent if it had been in place at the height of the financial crisis.
Europe has no strategy for growth, no strategy for jobs, and in truth, no strategy for saving the euro. The project is broken beyond repair.