Today, the world is expecting Mario Draghi to announce a formal round of Quantitative Easing in the Eurozone. And I say “formal” because actually, it’s already been sort of happening through the ECB’s purchases of “peripheral bonds”*.
*That is: buying the government debt of the peripheral Eurozone countries, like Cyprus, Greece, Italy, Portugal, etc. These bond purchases were “sterilised”, meaning that every purchase had to be matched by a removal of equal liquidity from the system. But from what I understand, in practice this just meant that normal banks would briefly have higher reserve requirements with the ECB (ie. they were required to keep more money in their bank accounts at the ECB) – and given that they were already holding some excess reserves (because they weren’t lending as much as the ECB would have liked), the impact was not really that important.
Given that the ECB is announcing this process many years after the Fed, and the Bank of England, and the Bank of Japan, I feel like there are two obvious questions:
- Why the delay?
- Will it work if they’re so late to the party?
If you’re wondering how QE works, I do have an earlier post on this (check it out here), but here is the basic summary that I lifted off this excellent article at the New York Times*:
*It really is excellent – I’ve read a stack of Euro QE articles, and I liked this one best.
Why The Delay?
The big reason that everyone throws around when asked this question is “Germany” and “the Bundesbank” and all those German fears of hyperinflation. And to an extent, I guess that’s true.
But I’d bet that another big reason is that we still don’t know if QE works. Almost every article I’ve read describes the various rounds of QE in the United States as having been “largely successful”. To which I’ll say:
- On what basis?
- They did it for six years, and then they ended it. The US economy recovered a bit, which economies are bound to do with enough time anyway. And six years is quite a long time. I’m just not sure that you can say “The proof that QE worked is by thinking about what could have been had QE not happened”. That is not proof. That is speculation.
- Japan has been trying it for decades with near no success.
- All that QE really accomplished was a spike in asset prices.
- Almost none of the impact was felt by consumers. Who are the folks responsible for greasing the economic machine.
- And while some might argue that the spike in asset prices has to converge on consumption spending over time – I’m just not convinced that’s always the case, especially in situations where the top 1% own almost half of everything (see here and here).
Anyway. The point is, the political will seems to be tending toward allowing some more extreme action to be taken. And I’m sure that Mario Draghi is at the point of trying almost anything.
But will it work?
In the end, I think we’re almost certain to conclude that it will. Mainly because the commentary will end up saying “Imagine what would have happened had they not.”
But that aside, on the face of it, there are some rather glaring issues:
The “How” is a big one
There are no eurobonds for the ECB to buy (unlike the US treasuries that the Fed was mopping up). The ECB is going to engage in the equivalent of the Fed buying up the bonds of individual States.
So does the ECB buy up the bonds of the states that most need stimulation (like Greece, Cyprus, Portugal), which would deeply displease the Germans? Does it buy up the bonds by proportion of Gross National Debt, in which case, Italy and Germany would get the largest stimulus? Does it buy it by proportion of GDP, when again, Germany would get the largest injection of liquidity?
Many people are making an issue out of whether the ECB does the actual bond-buying, or whether it delegates out the bond-buying process to the various national Central Banks – but in my mind, that’s just semantics for the benefits of the Germans (“See? You’re not buying the debt directly..”). Ultimately, it amounts to much the same thing.
The bigger issue is how they divvy up the actual bond-buying.
Then where will all this extra liquidity go?
Regardless of how they do it, that extra liquidity will flow into the market – and past experience would suggest that the money will flow straight into financial assets and alternative currencies and carry-trades offshore. Possibly also into some commodities – which would certainly be a bit of welcome relief for those markets.
But the flow of money into alternative currencies is almost certainly why (in my mind) the Swiss abandoned the euro peg. And if you want my vote, I’d be throwing money into the Danish krone – because I’m just not convinced that they’re ready for what defending that exchange rate will entail. Especially if (when?) the Wall Street FX traders spin their leverage into Denmark.
The Big Question
The real hope is that the spike in asset prices and the drop in bond yields will encourage European firms to take advantage of the cheap capital and launch themselves into consumer sales.
And this would hopefully have a spiral effect – expansion creates jobs, which creates consumption, which validates the expansion, and so the recovery kickstarts.
To be honest, I feel like this ignores the reality of real-life business. Most businesses don’t launch expansion programs in order to create demand for their products. They expand in response to higher demand.
Which is why you need the fiscal stimulus first. Otherwise, you’re asking the horse to push the cart.
Unfortunately, German austerity…
But enough of the gloom
QE is actually really good news for investors! Especially if you’re the smaller investor on a street that’s not quite Wall Street who will actually consume a bit more if your general wealth goes up.
Because if today goes as expected, asset price spike ahoy.
Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.