ECB's QE: Too Little, Too Late

Proof that Mario Draghi has the votes he needs to launch a European Central Bank (ECB) version of the U.S Federal Reserve's quantitative easing (bond buying) program when bank governors next meet on January 22 is David Jolly's "Swiss National Bank Abandons Minimum Exchange Rate Against Euro":

The Swiss National Bank said in a statement that it was giving up the minimum exchange rate of 1.20 Swiss francs per euro, less than a month after it had reiterated a pledge to continue to support that floor by buying the euro in “unlimited quantities” if needed.

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The euro, used by 19 nations, has been a one-way bet since last May, falling about 15 percent against the dollar to a nine-year low, partly because of expectations that the European Central Bank would announce its intention next week to combat economic weakness and deflationary pressures by buying eurozone government bonds on a large scale. 

In that policy, known as quantitative easing, the central bank would effectively be printing money, increasing the supply of euros relative to other currencies and driving down its market price. 

Phyllis Papadavid, foreign exchange strategist at BNP Paribas in London, said after the Swiss central bank action that monetary authorities were “still sensitive” to the overvaluation of the franc, but that they had adapted to changed conditions — particularly the dollar’s recent rise — by changing course.

With prices dropping 0.2 percent in December, deflation has come to Europe. This, along with a favorable appeals court opinion yesterday supporting the ECB's earlier 2012 announcement that it would purchase government bonds of eurozone member states on the open market, has strengthened Draghi against the German naysayers. For an excellent summary of the ECB's planned foray into quantitative easing (QE) see Jack Ewing's "Devil May Be in the Details on European Central Bank Bond-Buying":

A solid majority on the central bank’s 25-member Governing Council appears, based on recent public statements, to favor broad bond-buying. Their position was strengthened by the opinion submitted to the highest European appeals court on Wednesday in response to a lawsuit by German citizens seeking to block a previously planned bond-buying program that Mr. Draghi announced in 2012 but never deployed.

The ECB's QE is already being criticized as too little, too late. Analysts doubt that purchasing €1-trillion worth of government bonds will cure deflation which has to do with withered demand. Plus, the Governing Council will most likely not act until March; it will only make a commitment to a QE program at its January meeting, but details won't be available until it reconvenes in March.

From now until then the ECB will have to figure out a formula for which bonds to buy. There are no "eurozone" bonds, only bonds issued by member nations. As Ewing clearly summarizes:

Because of the large number of unanswered questions, the European Central Bank may not be ready to announce details of a bond-buying program next week.

“It’s almost impossible for the E.C.B. in this environment not to act,” said Mujtaba Rahman, an analyst at Eurasia Group. But, he said, “We think it’s a two-step move — announcement in January, further details in March.”

Some elements of such a program are a given. The central bank would buy bonds on the open market — not directly from governments, which would be a violation of its charter.

But the bank will have to figure out how to deal with the lack of Pan-European assets comparable to the United States Treasury bonds that the Fed purchased in its quantitative easing program.

The simplest and most likely option would be to buy bonds in proportion to each eurozone country’s share of the central bank’s capital, which is calculated according to each member state’s population and gross domestic product.

The drawback to this method is that it would mean buying large quantities of German government bonds, which are already in heavy demand — so much so that on Wednesday the yield on the 10-year German bond reached a new low. 

Germany accounts for 18 percent of the European Central Bank’s capital, more than any other country. (Malta, with 0.65 percent of the central bank’s capital, has the smallest share.) Market interest rates on some other German government bonds are already below zero. So it is not clear what purpose, if any, would be served by pushing the rates even lower, as would happen if the European Central Bank started buying.

A second option would be to buy only highly rated government bonds — those of France, Finland and Germany, say, while avoiding the bonds of governments with riskier finances, like Portugal or Greece. That approach would answer German concerns that taxpayers could be stuck with the bill if some eurozone governments were to default on their debt.

In theory, if the European Central Bank drove up the prices of highly rated bonds, private investors would turn to the bonds of weaker countries instead. But it is not certain that would happen. If not, the E.C.B. would not achieve its goal of providing relief in heavily indebted countries like Italy.

A third option would be to buy bonds in proportion to the outstanding debt of each eurozone country — the higher the debt level, the more bonds the central bank would buy. This alternative would favor countries that are the most deeply in debt and need the most help, like Italy. But conservative critics in Germany would probably complain that these countries were being rewarded for irresponsibly running up huge debts.

It is hard to imagine a situation where Germany would green-light option three, the only option that Ewing brutes that might have a meaningful impact. So Draghi's QE will not be enough to arrest eurozone deflation.

Draghi has made clear that he wants no part in any candidacy for the Italian presidency (Elisabetta Povoledo, "Resignation of President Will Test Italy’s Premier"). Hopefully this augurs ill for the fresh-faced neoliberal PM Matteo Renzi.

Neoliberalism has to be torn down. Syriza is maintaining its narrow lead going into Greece's January 25 parliamentary elections. If elections were held today in Spain, Podemos would gain a majority (see Vicente Navarro's excellent "What is Going On in Spain? The End of an Era and the Beginning of Podemos").

The mainstream parties of the big three -- Germany, France and the UK -- are under assault from the Right. That is not going to change. The left-hand of the mainstream political duopolies will rush to defend the right, which will have the effect of further disillusioning voters in each nation. Maybe out of this disillusionment real Leftist parties will arise in the big three.

If Hillary is nominated, a similar hopeful possibility will confront voters in the U.S.

The answer to European deflation is obvious. Why not a continent-wide building program similar to China's massive investment in infrastructure?