Now Europe Prints Money

Posted by on Oct 24, 2013

Now Europe Prints Money

Under the relentless pressures from the European economic structural crisis, the European Central Bank (ECB) has eventually caved in, and has joined the US Federal Reserve Bank and the Bank of Japan to print money, alternatively dubbed as “quantitative easing”, or long term refinancing operations (LTRO).


The ECB has pulled the European economies from the brink of a severe credit crunch, and a potential fiscal collapse in a number of EU member countries. The short term benefits are almost self-evident. European and global investors are relieved. And, the European political leaders have a sigh of relief, at least for now.


Technically, of course, the ECB’s action is nothing more than a simple measure of “buying time”. In many respects, the ECB’s action is very similar to the US Fed’s action in the period immediately after the 9/11 attack on New York.  Allan Greenspan introduced an unprecedented and prolonged monetary easing in the US. For sure, he averted a possible recession, or even depression, in the US and by extension in the world economy. Yet, within seven years, the compound effects of a prolonged monetary easing evolved into a phenomenal financial bubble. Asset prices rose considerably, financial institutions in particular ignored some of the basic rules of credit extension, and investment bankers amassed wealth like never before. To put this into perspective, in 2000 the global GDP was USD 32 trillion; by Q3 of 2008 it had grown to USD 62 trillion. These nominal figures clearly reflect that the world economy expanded at an unsustainable rate.


By August 2008, the bubble in the financial system burst and with it the super-cycle of growth came to a sudden and painful halt. One of the oldest and most respected investment banks, Lehman Brothers, was declared bankrupt and many others followed. The global economy went to a sharp decline, some regions more than others. In many respects the global economy has not yet fully recovered.


Now, it is Mr Draghi of ECB who is following in the footsteps of Mr Greenspan. The reasons are very different in Europe 2012 than in USA 2001. The economic and financial consequences may not be that different. The short term focus however is on saving Europe, averting a Greek fiscal collapse, and providing immediate socio-political relief.


Mr Greespan’s strategy to buy time also led to a number of structural problems in US and elsewhere. Mr Ben Bernanke, Mr Greenspan’s successor, intensified the money printing in US. The Bank of Japan had been doing the same for nearly two decades. Loose monetary policy by these three major central banks caused a range of domestic and international fault lines. In Europe in particular, ‘cheap money’ caused a ballooning of government debt, exacerbated by the bail outs offered to the ailing banks in UK, Italy and France in 2008 and 2009. By 2012, the US federal fiscal debt stood at US$ 16 trillion and rising. At the time of writing, the US is in the midst of a fiscal and economic dilemma. This has also become the number one election issue in this year’s presidential elections.


Both in Europe and US, there are deep structural issues that need lasting solutions. No amount of short term palliatives in the form of central bank monetary easing will take the place of the required structural adjustments. However, in both regions, there is an evident lack of political will to implement the necessary measures. In the meantime, the central bankers are trying to buy time in the hope that their extraordinary policies will provide the breathing space for the economy to recover and for the politicians to gather the will to tackle the thorny issues of the political economy. For the economy to recover, it is necessary that the banks use the ‘quantitative easing’ to on-lend to the economic agents on favourable terms. Yet neither in US nor in Europe are there signs of such bank lending.


There is therefore every risk that the ECB’s LTRO may well strengthen the balance sheets of the private banks and boost the banks’ executive bonuses, all at the expense of the ECB’s own diluted balance sheet. If the experience of the US Fed is anything to go by, the ECB is paving the way for some more structural fault lines to develop. Watch this space!