Europe will begin a full fledged version of quantitative easing beginning in March of this year. To many in the markets it comes as a relief. They have allowed themselves to believe that expanding the money supply through the purchasing of government debt, will bring back growth to the staggering continent. The hope is that this infusion of new money will stimulate the economy enough, to allow a return of the lost prosperity of a bygone era. The policy makers of Europe insist that this will finally deal with the ruinous unemployment rates in many parts of Europe,especially among the young which are approaching 50%. In the case of Spain, it already exceeds that milestone.
If only it were true, that this will be the result of adding 1.14 trillion Euros, the equivalent of 1.27 trillion USD (United States Dollar) to the European economy from March 2015 through September 2016. This will be at a rate of 60 billion Euros a month. If it were only that simple, that whenever a nation has a time of low growth and higher unemployment, you simply expand the supply of money to re-balance the economy once again.
The mere announcement by the European Central Bank (ECB), of the intent to begin the policy of quantitative easing (QE) in Europe, caused Switzerland to abandon their peg to the Euro. The immediate result was an appreciation of the Swiss franc by 20% against the Euro. Even though this rise in value for the franc will damage exports from Switzerland immensely, the Central Bank there realized the folly of QE in the long run.
The value of the Euro in relation to the American Dollar has also dropped below the 10 year trading range. The Euro now valued at $1.12 USD is at a 12 year low and may well drop even further. There are many that fear parity of 1 to 1 between the Euro and the USD is not far off, as quantitative easing takes hold in Europe.
Europe as a whole had been prosperous for 30 years after World War II. The ending of the economic upheaval of the 1970s, did not see a strong return to growth throughout the continent in the decades that followed. Prosperity would become more uneven across the various countries. Some countries began long periods of slow growth and stagnation.
Germany would go through several economic dislocations before deciding that as always, reforms in taxation, labor, investment and regulations would better serve the country. Known as the Sick Man In Europe at the end of the 20th century, Germany returned to the principles and practices of the past that had served them so well. The country’s prospects soon changed and once again became a model of industrial growth and efficiency. The reward was a surge in exports and tax revenue.
Contrary to what the central bankers would have you believe, if a country embarks on a policy of printing a surplus of currency which brings about a devaluation, real investment money will soon flee the premises. This flight of investment capital, more the negates the stimulative effect of the devaluation. It will end up being a net loss for Europe as a whole.
If there are no structural economic reforms to coincide with QE, there will unlikely be a return of sustainable growth. The ongoing devaluation will merely lead to an ever increasing flight of investment capital. The temporary expansion in the European economy will continue to need an influx of liquidity, to maintain higher prices in assets, stocks and other tangibles. The stock market has already advanced to a 7 year high in Europe as a result of the move on QE.
Will there be a boom in exports as they become cheaper with the declining value of the Euro? In the short term this is quite likely, in the long run it is more doubtful. Much as international investors will adjust by fleeing the continent in search of better prospects, export competitors will adapt to the new price and quality constraints, to maintain market share.
Japan
has tried quantitative easing for years with little positive results. The United States has done a 6 year stint, and yet the American economy is still undergoing one of the slowest economic recoveries, since the end of the Second World War. The United Kingdom also experimented with a dose of it. Europe will find that QE alone, will not be the answer to what ails the economy.
The currency wars will soon intensify. Denmark just lowered its interest rates to below zero, to stop the Danish krone from rapid appreciation, in response to the latest ECB action. In North America, Canada as well, has just lowered interest rates. It will soon be a race to the bottom. In contrast as much as the United States may wish to raise rates after 6 years of historic lows, it will become more difficult if everyone else is cutting theirs in response to lower overall growth .
One of the other promises that quantitative easing advocates make is that the policy will ward of deflation. This much is true. If you stick with a policy of QE long enough, inflation is more likely to be the issue before long. Interest rates will be lowered in the short term. The benchmark rate charged to banks to have the ECB hold their money, is already below zero. However, the result of QE will be higher interest rates in the future to combat inflation and and a deprecating currency.
Bonds yields were already at historic lows in Europe. The 10 year government bond yields ended last week at 0.54% for France, Germany 0.36%, Italy 1.52% and Spain at 1.37%. The rates are getting so low that it soon will not matter. German yields for example, have gone from 1.66% to 0.36 within the last year. As a result of loose monetary policy rates in the United States as well, have declined from 2.27% to 1.80% Is it any wonder that the savings class is being wiped out in the West?
What will these lower yields actually mean to the economy of Europe? Does anyone believe that if interest rates just went a bit lower, it would unleash a torrid of extra borrowing for business investment and expansion? What is holding growth back now is rigid labor laws, punishing taxes and onerous government regulations. All part of the welfare state that was supposed to make Europe a wonderful place for the working classes.
The immediate beneficiary of quantitative easing in Europe will be the United States in particular. International investors will gravitate to the higher yields and better investment opportunities there. The United States is expected to experience better rates of growth in 2015, than in most other advanced countries in the world. The higher economic prospects there, will bring an infusion of new money into American stock and equity markets.
Much of what is the problem in Europe today is the lack of demand caused by excessively high consumer household and sovereign debt. Financial institutions that were in deep trouble during the Great Recession starting in the United States and the resulting panic in Europe, have been mostly stabilized. Still they are reluctant to make new loans and the huge amount of debt in the economy, is preventing a rebound in consumer demand.
Current Account Imbalances
Germany is against more stimulus. In the mind of their Chancellor Merkel, which is shared by many Germans it lets nations like Spain, Italy, Greece and more recently France, to put off the needed economic reforms. It also delays the urgency for them to balance their government budgets. By balancing the primary budget deficits first, that is current spending that does not include interest payments on debt, is the only way to be able to tackle the larger issue of sovereign debt. The accumulation of all this debt is weighing heavily on the economy of Europe as a whole.
If the West as a whole would like to see a return to prosperity there will need to be a time of sacrifice. This will mean that nations must learn to live within their means. The addiction to debt on both a consumer and government level, necessarily has to end. Social programs would need to be paid for through higher taxes. This would quickly make voters decide, what economic supports are practical and affordable.
Politicians could no longer promise government programs that are not cost effective. This would in turn stop the need to print excess currency, which could possibly allow a return to a fixed exchange rate, among the major nations of the world. Finally, this would force nations to learn to be more efficient and productive. Once the governments of the world are forced to adopt policies that foster greater investment and business expansion, unemployment will then decline. This at long last, would usher in a new period of growth and prosperity.
Is the above solution likely to occur? Not as long as political leaders are content to allow central banks to keep on printing more money by buying up assets and government debt. The disaster will really unfold, when investors begin to lose all confidence in the national currencies of these offending nations. When this moment arrives and it could come suddenly, there will be a cascade of defaults and bankruptcies, that will simply overwhelm the present financial institutions and safeguards. The markets will simply collapse along with the major world currencies, bringing untold misery to countless people.