Thus far, the European Central Bank (ECB) remains the only one of the world’s major central banks that has resisted QE in the wake of the global financial crisis. That hasn’t been a matter of prudence— it has been a matter of policy paralysis in the European Union, with bitter divisions between creditor and debtor nations preventing a coordinated response.
In the view of many analysts, including ourselves, Europe now faces the fate of Japan from the 1990s on if it doesn’t manage to get a better policy response in motion. The writing is on the wall with the Eurozone’s declining inflation rates and economic growth rates.
In the U.S., the U.K., and Japan, central banks responded to the danger of deflation in 2008 with massive programs of quantitative easing (QE). Further rounds of QE followed as the recovery gained and lost steam. In each round, the central bank dramatically increased the size of its balance sheet by purchasing the sovereign bonds of its host country— and the Federal Reserve in the U.S. also purchased asset-backed securities.
The 2008 crisis was in essence a collapse in the world’s shadow-banking sector, and the global financial system has been reflated by central banks. Officially, central banks have said that the purpose of QE was not to lower the value of a country’s currency, or to fund deficit spending by the government. But the reality is that QE has allowed both of those things to happen— some see this as a welcome and well-understood side-effect. Germany does not— at least thus far. Once recession begins to bite more deeply in Germany, perhaps they will moderate their position.
German voters remains steadfastly opposed to the purchase of sovereign bonds by the ECB. They don’t want the Euro to be forced down too far, because of their traumatic historical memory of the hyper-inflation that brought down the Weimar Republic and paved the way for National Socialist populism. And they don’t want ECB bond purchases to fund the deficit spending of Europe’s peripheral economies— countries like Portugal, Spain, Italy, and Greece, whom German sentiment regards as lazy spendthrifts.
QE — Imperfect, But…
We believe that decisive central bank action did indeed prevent a 1930s level Depression, and we can be grateful that scholars of Depression-era economics and monetary policy were at the helm when the crisis occurred. They knew that the initial policy response to the Great Depression— one of fiscal and monetary tightening — was exactly the opposite of what was needed.
Europe has not fallen into a depression— largely, we believe, because so much of the stimulus produced elsewhere in the world has found its way into European financial markets. But they are stagnating, with very low inflation, persistently high unemployment, and sluggish growth that seems to be spiraling into recession once again as we write.
Mario Draghi, the head of the ECB, has been creative in doing everything within his power to grow the ECB’s balance sheet while tiptoeing around the edges of Germany’s displeasure.
His most aggressive move thus far has just begun, spurred by continuing dismal economic data from the Eurozone. The ECB is still saying that they not going to purchase sovereign debt, but recently they have begun purchasing securities from European banks— essentially, various kinds of asset-backed securities The ECB has begun buying, and we’ll get weekly updates on its purchases beginning next Monday. The first purchases were reported to have been from BNP Paribas and Société Générale, two large French banks, as well as banks in Spain and Italy. Press reports state that .2 trillion of these securities will be purchased in the next two years. If so, it is highly bullish.
Europe’s Response— Is It Enough?
The action is encouraging, as is Draghi’s determination— which almost by itself has seemed able to draw Europe back from the brink over the past several years. He seems to be a capable and determined leader.
Investment implications: Europe has not shown us that it is capable of defeating its own internal strife and implementing the policies necessary to overcome its malaise. The actions of the ECB under Mario Draghi have been heroic— but we will have to watch to see that growth-promoting policies will be carried forward. Consider going long Europe and short the Euro. Several ETFs will accomplish this.
For more commentary or information on Guild Investment Management, please go to guildinvestment.com.