Yeah, yeah, I know — that was the big fear two years ago during the first round of the sovereign debt crisis. Then European Central Bank President Mario Draghi gave his famous “bumblebee” speech, and said he would “do whatever it takes” to save the euro, and flash forward, here we are, knocking on 2015, and Europe is still standing.
But here’s the thing: Draghi is having a really hard time persuading his colleagues to launch full-blown quantitative easing, and the longer it takes, the more his authority erodes. He talked about a 1 trillion euro attack on deflation about six months ago, and nothing has happened; actually conditions are worse.
|Does the euro zone have a future?|
Ambrose Evans-Pritchard, the London Telegraph economics columnist, observed late last week that the ECB is thus facing a “full-blown leadership crisis,” which has the potential to rock financial markets if not halted or contained.
Media reports say that half the ECB’s six-person executive board — representatives of Germany, France and Luxembourg — refused to sign off on Draghi’s post-meeting statement last week, a rare mutiny.
The problem is that the dissenters refuse to allow full-blown QE until they are ready, and they never plan to be ready. This is because they consider sovereign bond buying to be essentially a “fiscal transfer” that would amount to the ECB stepping into a governmental, rather than a monetary, role.
The Germans are afraid that Draghi is setting the ECB up to be the buyer of last resort of a slew of sovereign debt floated by Italy, Spain and Portugal. They believe the German people did not sign up for that when creating the euro, and that it violates their sovereign rights.
Draghi on the other hand is basically saying that the only way to save the euro, and the euro zone, is to acknowledge that a successful monetary union depends on a fiscal union — so yes, a European super-state is necessary going forward. Goodbye individual countries, hello Super-Europe.
The euro zone has muddled through so far without really confronting the hard issues. If and when they are forced to do so, either by persistent deflation or recession or both, the global financial system will gasp — at least for a while.
Euro-zone divisiveness over a monetary and fiscal union could well turn out to be the financial story of 2015. We care about it because we are depending on the Japanese, Chinese and the euro zone to pick up the QE baton from the U.S. next year now that the Federal Reserve has completed its part of the global reflation relay race.
If the euro zone never does launch QE because the Germans and French continue to object, there will need to be a downward adjustment, or dislocation, of market expectations. That adaption process would not be pretty for risky assets, and it could come in the form of a sharp break rather than a slow bend and twist.
While Draghi noted downside risks to inflation expectations in his statement, some observers said that he did not signal the same sense of urgency to address inflation as he did last month.
Investors are trying to read something into everything that ECB officials say because the region is in such terrible shape that there is a gnawing fear that officials are not aware enough of the gravity of the situation. There is a desire to make sure that the homeowner knows his house is burning, and plans to call the fire department, rather than just pose for cameras amid the glow of the flames.
Granted, Draghi is in a tough position, having to mesh so many countries’ interests, and getting so little cooperation from fiscal authorities. But at some point, investors are saying, it is time to stop talking and actually do something to help boost economic activity in the euro zone.
BNP Paribas has said that euro-zone inflation is likely to average zero percent in 2015, after turning negative this month. Ashoka Mody, a former European Union and International Monetary Fund exec, told reporters that the ECB’s measures are “woefully behind the curve.” According to the London Telegraph, he added: “For anyone who wants to see it, a debt-deflation cycle is ongoing in the distressed economies. The authorities have very nearly lost control of a process that will become ever harder to manage as it becomes more entrenched.”
Mody noted that the ECB repeatedly asserts that it will act “if needed” but declines to spell out what that means and why it continues to delay when the inflation level, now 0.3 percent, is already well below target. “Cheap talk is a legitimate policy tool. But talk can also create a cognitive bubble,” he said, according to the Telegraph.
No one is arguing that quantitative easing in the form of sovereign debt buying will be a panacea, but it can at least help to keep down the cost of capital while governments, businesses and individuals stabilize their finances and start to invest and take risks again.
This article is brought to you courtesy of Jon Markman.