European Central Bank Embraces QE, For Better Or Worse by Gary D. Halbert
FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
January 27, 2015
IN THIS ISSUE:
1. European Central Bank Announces Quantitative Easing
2. Why QE Bond Buying May Not Work in Europe
3. ECB Bond Buying Will Devalue the Eurodollar
4. IMF Cuts Global Growth Forecast For 2015/2016
5. World Bank Cuts 2015 Global Economic Outlook
European Central Bank Announces Quantitative Easing
Last Thursday, European Central Bank (ECB) President Mario Draghi announced the much-anticipated launch of a sovereign bond buying program at the rate of €60 billion ($70 billion) per month known as “quantitative easing.” The amount of the monthly purchases was slightly higher than had been expected.
The long-expected introduction of Eurozone government bond purchases, which could in total amount to as much as a trillion euros ($1.3 trillion), means that the ECB will join the US Federal Reserve, the Bank of England and the Bank of Japan in launching a quantitative easing (QE) scheme.
The program will be open-ended, lasting until at least September 2016, Draghi told reporters at his regular media conference last Thursday, and will start in March of this year. The European Central Bank’s hope is that it will boost the region’s painfully low inflation rate, which came in at an annual minus 0.2% in December. Explaining the ECB’s decision, Draghi said:
“Inflation dynamics have continued to be weaker than expected. While the sharp fall in oil prices over recent months remains the dominant factor driving current headline inflation, the potential for second-round effects on wage and price-setting has increased and could adversely affect medium-term price developments.”
The ECB will purchase euro-denominated sovereign debt issued by Eurozone members. The vast majority of the QE purchases will be subject to risk-sharing arrangements with other European national banks designed to limit the amount of risk the ECB takes on its balance sheet. Again, the monthly bond purchases will commence in March.
The question is whether the ECB’s QE bond buying program will be successful in boosting the European economies and heading off deflation. While the size of the monthly bond purchases was slightly larger than initially expected, the ECB will be limited to buying a maximum of 17% of Eurozone sovereign debt offerings. That compares to 21% purchased by the US Fed and 27.5% by the Bank of England in their respective QE programs.
When making such comparisons, the obvious question is whether or not the QE bond buying programs in the US and the UK really worked. Some say the respective QE programs served to head-off a depression-like disaster in 2008. Others argue that these massive QE programs did little to reverse the effects of the late 2007-early 2009 financial crisis.
I will discuss the likelihood that QE in Europe will work, or not, below. Whatever the outcome, the ECB has now used the last tool in its toolbox.
Why QE Bond Buying May Not Work in Europe
Central banks in the US, England, Japan and now Europe are fully invested in the theory that zero interest rates and bond buying are stimulative and add to inflation. Yet growth, inflation and median incomes keep going down. And deflation is spreading in several European countries.
There are several reasons to question whether QE will work in Europe. One of the main goals of QE is to bring bond yields down; however, 10-year bond yields in France and Germany are already near zero, at 0.55% and 0.37% respectively. Maybe they are headed in the direction of the Swiss National Bank which last week abandoned its currency peg to the euro and now charges depositors 0.75% to hold reserves at the central bank.
Another negative side-effect of the European Central Bank’s large bond buying program is that it may give European governments a further excuse to delay or avoid real economic reforms. Central bankers should be forcefully urging their governments to pursue practical growth-oriented solutions that encourage private investment and hiring. Instead, they’ve finally decided to embark on an ambitious quantitative easing program – even though QE hasn’t worked as expected where it’s been tried.
US, UK and Japan central-bank balance sheets have grown by an extraordinary $7 trillion since the 2008 crisis. Yet many parts of the world are in or near recession, including Japan, Latin America, Eastern Europe and most of the Eurozone.
As I will discuss below, the World Bank and International Monetary Fund have just lowered their 2015 global growth forecasts, and the IMF knocked more than $5 trillion off its October estimate of 2015 world GDP due to recent declines in commodities and currencies and the slide toward deflation.
Central bankers apparently believe deflation can still be halted by what Milton Friedman once called a “helicopter drop of money,” but it isn’t clear they have the right tools. As noted above, central bank reserves in the US, UK and Japan are already in massive excess. Adding more, as the ECB is expected to do, probably won’t add growth, and it remains to be seen if it will reverse spreading deflation.
A better approach would be to promote growth the old-fashioned way, through tax cuts, robust after-tax profits at small businesses, investment in startups and more jobs. In most of the developed world, that kind of growth has been on hold, waiting to find a path through political and regulatory obstacles.
The risk, as inflation rates fall into negative territory, is that central banks will double-down on their current set of ineffective policies, making matters worse and allowing recessions and deflation to spread.
The US consumer-price index fell 0.4% in December, the largest decrease in six years, and is on track for another large decline in January. As a result, the Federal Reserve is sending signals that it may delay rate hikes this year, even though six years of near-zero rates haven’t produced satisfactory growth or price stability. But that’s a topic for another time.
It remains to be seen if the €60 billion monthly bond purchases will reverse the deflationary forces unfolding in Europe. However, there is rather broad agreement that the QE program will do little to boost growth in the Eurozone and may not help those countries most in need of it.
European Central Bank Bond Buying Will Devalue the Eurodollar
The other problem is the euro currency itself. The European Central Bank will be using QE to promote the devaluation of the euro as a way to make up for Europe’s uncompetitive tax and regulatory policies, much like the Bank of Japan has done with the yen – which unfortunately did not result in the desired increase in growth. Here, too, the euro has already devalued significantly against the US dollar just in the last year.
The European Central Bank’s primary mission is to reverse deflationary forces now unfolding and increasing inflation to around 2% (if that is possible). The last time that Eurozone consumer price inflation (CPI) was measured at 2.0% was December 2012. Indeed it has been under 1.0% percent since September 2013.
The central bank is apparently willing to see the euro move even lower against the US dollar and other major currencies. As you can see in the chart above, the euro is not far from parity with the US dollar. Devaluing one’s currency