The Euro crisis has been postponed. The Euro area has now adopted the very popular approach in the modern west of simply printing more cash to see them over a rough patch. The European Central Bank’s decision to lend more than half a trillion euros to Euro area banks, for 3 years at 1%, was the nearest thing to a free gift to the banks they thought they could get away with.
In the short term it has worked. Very weak banks now look stronger, because they can now get their immediate cash needs direct from the ECB. They are not so beholden to the markets, who were getting prickly about which banks to lend to, how much to lend, and what price to charge. Some banks are using extra cash borrowed cheaply from the ECB to buy into the sovereign bonds of Italy and Spain. They can then pocket the difference between the 4-7% yield they pick up on the bond, and the 1% they pay for the money. It’s a great idea all the time they do not lose on the capital value of the bond. As banks buy more of these bonds, so it gets a bit cheaper for the governments to borrow, easing the pressures on them. It’s an indirect way of doing what the US and UK did directly – simply buying up their own debt to make it cheap.
In the UK the main effect of quantitative easing has been to keep government borrowing rates very low, allowing the government to go on spending way more than it raises in taxes. The government via the Bank of England now owns more than one quarter of all the government debt in issue. It has bought up enough to keep government borrowing rates on the floor, and to allow nervous foreign holders of the debt to sell out and move away. The authorities had hoped it would result in easier credit throughout the economy, but that was never likely. The commercial banks are still constrained by the regulators, so the cheap liquidity circulates mainly within the government sector. The private sector faces credit shortage and relatively dear loans. The UK looks likely to do more of this. There are various stories in the press saying that the Bank will do some more once it has completed its second programme of £75 billion. This means that for most of this year we can expect low government borrowing rates, and continued high levels of government borrowing.
In the US the authorities have so far avoided another round of quantitative easing. Instead they are currently trying to lower longer term rates by selling shorter term debt and buying longer term debt within the large total of QE already established. The US is doing more to cut its deficit than the UK judging by recent figures. According to spin doctors on both sides of the Atlantic the opposite is the case. One respected institution in the UK has now confirmed that we have had very few cuts inUK government spending so far – total current spending of course is well up on two years ago – whilst the latest figures in the USA do show declines.
Does all this money printing matter? Why didn’t people do it before, if the authorites have found a painless way of paying for all that excess public spending? In the past advanced and disciplined countries have avoided money printing on a large scale, believing it to be inflationary. If an economy is operating at capacity and you print and circulate a lot of extra money, the main effect should be an increase in the price level. You have too much money chasing too few goods.
The authorities today in Euroland and the UK believe there is spare capacity. They therefore hope that printing more money will mainly go into calling more of the unused resources into use, creating a free lunch effect from printing more cash. Unfortunately, if the new cash is all spent within the public sector, and entails facilitating the build up of yet more public debt, it just defers the crisis until the state has to repay that debt, or until the markets panic at the size of the extra debt.
In Euroland it is clearest. The markets have already taken fright at the size of the public debts in Greece and Portugal. They were beginning to take fright at the scale of the Italian and Spanish public debts. Printing money has not solved the Greek and Portuguese problem, but it has temporarily eased the market’s view of the Italian and Spanish problems. The authorities would be wrong to think this is a permanent fix. If Italy and Spain use the time well that the extra money has purchased, to cut their deficits and make their debts more manageable, it will work. If they carry on as before, thinking they can build up even higher levels of debt, at some point the markets will do to them what they are doing to Portugal.
In the US and UK the authorities have other options. Printing lots of money can lower the value of the currency, helping competitiveness and cutting living standards by stealth. There is no need or likelihood of US or UK default, because the authorities can simply print the money to repay the old debts if all else fails. If they get to that point it will then prove inflationary. In the meantime the UK has bought itself some time. Inflation is falling for the time being despite the QE. It would however, be unwise to think that a country can adopt a new permanent model of paying for public spending by printing the cash. If you do it for too long there will be a day of reckoning.