fredag, februar 17, 2012

Gjeste-innlegg: The money printing bonanza of the ECB will not end well

The money printing bonanza of the ECB will not end well

av Protesilaos Stavrou
Protesilaos Stavrou er en gresk økonom og politisk vitenskap student som blogger om den europeiske union og du kan lese hans artikler på hjemmesiden lenket til i navnet.

I have long now been saying that the European Central Bank has been producing oceans of money (out of "thin air" of course), creating artificially low interest rates for sovereigns, at the expense of liquidity in the real economy. Thanks to its loose monetary policy, under the LTRO and the SMP, in conjunction with the bank recapitalization programme, private banks have been buying sovereign bonds of Italy, Spain and France en masse, pushing interests rates for governments well below the normal rate.

Before proceeding into reviewing the policy of the ECB, I need to show the following chart, which compares the assets of the ECB with those of the Fed, which has by the way been openly engaging in unprecedented quantitative easing for quite some time now.
The balance sheet of the ECB is exploding. Image Source: Zero Hedge
Debt monetization has long now been among the top demands of several power groups, from political parties to market interests. The principal idea being that by relaxing its monetary policy, the ECB would buy enough time for the hardly-pressed euro-states to carry out all the necessary reforms. And indeed it is true that by creating artificially favorable market conditions for sovereigns to issue debt (draw loans) the ECB has alleviated much pressure. Hence as far as the aspect of time is concerned, the now-relaxed monetary policy, seems to fulfill its function.

However this is miles away from saying that the policy is successful overall, for two very specific reasons:
  1. The (unreal) loanable funds remain scarce, meaning that not everyone will be able to get the desired amount. In other words, the demand for money is greater than the supply. Two are the sources of demand for loans: (i) states, (ii) individuals. Currently banks have a greater incentive to give loans (buy bonds) to sovereigns, firstly because they can use the bonds as part of their Core Tier 1 capital to comply with the new capital ratio requirements by June 30, 2012; secondly, individuals are considered much riskier than states, because of the high uncertainty in the real economy, deriving from the ongoing stagnation/recession, in contrast with the "risk-free" government bonds. 
  2. Individuals are facing decreasing revenues and increasing pressures to pay back whatever debts they may have. The economy is now in a recession, suggesting than strong demand will not come in the following months. To cope with this increasingly hostile economic environment, firms are in need of fresh cash (loans), to finance their activities. If firms can survive, then unemployment can also be contained and supply-led growth can gradually kick in. If they fail to do so, then bankruptcies accompanied by an increase in unemployment, will certainly follow.
Because states and individuals are both opting for the limited amount of loans available at the same time and because banks discriminate in favor of states, for their own reasons, we have already starting witnessing the following effects:
  • interest rates for sovereign fall since demand for their bonds has increased spectacularly, as banks have been rushing in to secure their newly-acquired money (as well as new loans from the ECB) and fill in their capital gaps ahead of the recapitalization programme,
  • interest rates in the real economy have been increasing since the amount of funds that is available to individuals is far less than the actual demand - excessive demand means higher prices,
  • the above two effects create the "perfect" conditions for large scale malinvestment, since resources are taken away from productive activities to fuel a cycle of artificial "economic activity" between bankrupt states and quasi-bankrupt banks.
With these in mind, we can return to the argument about buying time to save the system. Yes it is true that the collapse is postponed, but the fundamental cost is borne by the society at large, while the productive capacities of the economy are being diminished, suggesting that in the long-run, real economic growth will be weaker. All this will bring more debt, prolong stagnation and at some point inflation will kick in, to eat in the savings of the middle class.

Money printing bonanzas do not end well and this will not be an exception, especially since it is being followed all across the globe.

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