Sometimes truth is stranger than fiction. Who would have thought that a German led Euro area would decide to print Euro 80 billion a month to buy up corporate as well as government bonds from around the Eurozone? And who would have predicted that same German led Euro area would offer free money to commercial banks to lend on, or even offer banks a payment for borrowing money to lend to others? All those words about prudence, all that commentary about the need for a well run and disciplined currency have gone out of the window. The Euro authorities try to offer some hope to the many unemployed of the zone, and the Central Bank struggles almost alone to salvage some growth after years of recession and disappointing performance.
As strange is the wish to have some inflation. The zone has been more than successful at getting inflation down and keeping it down, something it shares with the rest of the advanced world. We have low inflation in most places today as a result of three mighty trends. The first is the large migrations, bring willing people from low wage and no wage societies to richer countries where they are prepared to take relatively low wages by the standards of their host country. The second is the creative destruction of the internet, slashing the costs of various business activities and giving so many more people cheap and easy access to the world market through a webpage. The third is the result of massive investment in commodity and energy capacity in past years, which has produced a state of oversupply in the main energy and commodity markets. China for example produces too much steel with knock on effects to the rest of the world’s steel industry. These pressures are being fought with monetary means. There is a desperate rush to the bottom as major currencies are deliberately expanded to try to devalue more than the next one. Each tries to steal a competitive edge and to trigger some domestic inflation from higher import prices.
There is of course an irony or contradiction in EU policy towards inflation and growth. The authorities are demanding each commercial bank holds more cash and capital for their current level of loans. That slows down loan and credit growth. The zone limits each country to borrowing no more than 3% extra of its GDP in any given year. This rules out further fiscal stimulus from the state making payments and investing money which it could currently borrow at very attractive rates. Yesterday the ECB hinted that it would like member states to spend and borrow more, but said this should only be done by those within the current targets. Germany is the country with most scope to expand her spending. Traditionally Germany is reluctant to do so, though she will need to spend a bit more on the migrants now arriving. It also said that member states at or near the 3% limit should nonetheless rejig their spending and borrowing to provide a better direct stimulus to growth from the spending they do do. The ECB wants an infrastructure led recovery.
The ECB should study Japan. Japan has had several phases of state led stimulus through extra spending and borrowing, with many large infrastructure programmes. Japan has gone through more phases of money creation and bond buying than the rest of the world, and has negative interest rates. Japan did succeed in devaluing the yen in recent years, but has now encountered upwards pressure on its currency despite the unorthodox monetary policy. The change of approach by the Chinese authorities to their currency, the yuan, and revised estimates of delays in increasing US interest rates have at least temporarily pushed the yen up. Japan’s monetary stimulus and fiscal stimulus combined have not been sufficient to push the Japanese economy into decent sustainable growth. The falling population makes this more difficult, and the numbers do look better on a per head basis. Much of the Euro area has the same problem of a falling population reducing demand directly, and an ageing population often leading to a more savings oriented culture. Japan has ended up with the biggest state debt relative to its output of any advanced country but without the growth that was meant to bring. It is only possible to sustain such a colossal debt by buying it up with newly created money, and keeping interest rates low or negative.
The ECB has done what it can. Its measures yesterday exceeded most people’s expectations. Any sensible person wishes them well, as the world would be a better place if the Euro area could grow at a decent pace and make bigger inroads into the high levels of unemployment. The problems remain that many people and businesses do not want to borrow, even at low rates, and banks still have balance sheet constraints limiting how much use they can make of this very generous offer of free money to lend to others. Some people and businesses already have debts enough, but others do not. They lack confidence or the income to be willing to borrow to invest or spend.Meanwhile the European dream is a nightmare for the younger people of the currency zone, with too many out of work and without hope of owning a home of their own. The older savers are not best pleased either.