Thursday, 22 January 2015

Europe Gets Even More QuEasy

Today the European Central Bank did what financial markets had expected, after lots of leaking of the policy moves. They announced they would buy securities in the asset markets, at a rate a little higher than had been expected of €60 billion per month, from March 2015. The policy will continue until inflation looks like getting closer to 2%, which, with the slump in energy prices, will be a while yet. In all likelihood, this extra asset buying (there has been some before) will amount to a bit over €1 trillion and last until September 2016, maybe longer. For comparison's sake, the new policy is around 10% of euro area GDP, compared to the US and UK policies of 'quantitative easing' that have amounted to more than 20% of GDP.
This policy move is the latest in a series that indicate there is no way out of the crisis. How can anyone believe that this policy, essentially making government bonds have even lower yields, can do anything for the economy when 10-year government borrowing costs were already less than 1% in Germany and France and less than 2% in Italy and Spain, the euro area's biggest economies?
The central bank's notion is that this will feed into private sector borrowing costs being lower, but there are some difficulties here. One is that there is very little demand to borrow to invest, given the dire economic outlook; the other is that banks would not to lend at anything like the sub-1% or 2% numbers to private investors, and the level of interest rates is not the problem. The problem is that there is no profitable avenue for large-scale capital investment, or any investment that does not depend upon government subsidy, tax dodging or some form of financial trickery. Even the countries that claim they have done better than the euro average - especially the US, but also the UK and Switzerland - are now faced with higher currency values against the ones that are under the market's cosh. Last week, the Swiss National Bank's made a dramatic move to abandon its 3-year attempt to stabilise its currency against the euro. This was done largely in anticipation of this week's action by the ECB and so far the euro's value has fallen 18% against the Swiss franc. Unsurprisingly, the euro fell another 1-2% today.
The ECB made a concession to German worries about the new policy. They said that 80% of the risk of the new purchases would be borne by national central banks, because central banks in the euro area might buy rubbish and face a loss. In its press releases today, they did not explain who would buy what, or how much. Because the scale of the buying, if it is not directed, would evidently be concentrated on the better risks - Germany, especially - a proviso was included: only up to one-third of a country's outstanding debt could be bought in this way, and the debt had to have a maturity of 2-30 years. Germany has around €1.1 trillion of debt outstanding, with less than this in the 2-30 maturity range. So these, the 'safest assets', will not be able to use up more than about a third of the new programme. German government securities out to a maturity of 5 years also have a yield that is zero or negative. So, presumably, this is good news for the government securities of France, Italy and Spain, the other countries with large bond markets.
The ECB's hope is that the lower yields will force investors to take on more economy-boosting risks. Instead, the likelihood is that there will be a continued reliance by capitalists on 'making money' through financial investment, something that further stretches the gap between value creation and financial accounting. On occasion, that gap is narrowed by a slump of financial market prices for bonds and/or equities, but the ECB has signalled that it will gamble for a while longer on trying to push the gap still wider.

Tony Norfield, 22 January 2015


Biswadip Dasgupta said...

Thank you for your illuminating description of the mechanics of Quantitative Easing - my question is how does this differ from the kind of "open market operations" we used to read about in our Macroeconomics courses which governments traditionally used to "loosen" monetary policy?

Furthermore - what are the "assets" the government buys up to increase the money supply and reduce yields/interest rate? Are these the assets which were previously sold by the government to raise funds for its spending?

I am looking forward to reading your thoughts on the unfolding situation in Greece. Keep up the good work!

Tony Norfield said...

Hi Biswap,

A few comments on this:

'Open market operations' are normally on short-term money market instruments and affect the rates on these. But recent years have not been 'normal', and central bank policy has switched more to trying to push down longer-term rates/yields, with the Fed's 'operation twist' and the various QE policies that involve buying bonds.

There is also another distinction to be made. If a central bank directly finances the government deficit (crediting the government with funds and taking on government securities), this is seen as 'bad' and potentially inflationary financing. Less frowned upon is the central bank buying government bonds in the secondary market. This does not provide the government with any new cash, but it takes bonds from private sector holders and gives them bank funds (cash). This method of pushing yields down is seen as good/OK.

Those are the subtle distinctions of capitalist finance these days!

Tony Norfield