After the Greek crisis, which highlighted the risk of currency collapse, the European Central Bank (ECB) must now purge excess public debt s. It is, inter alia, to issue currency to prevent these rising public debts consume European savings. This monetary approach would have been unthinkable at the time of the creation of the euro, when Helmut Kohl promised that the abandonment of the Deutschmark would be based on the German discipline, ie respecting one disinflation and strong currency. Unfortunately, reality has corrected the monetary hawks: budgetary policies have contributed to getting the economy to constantly touch the deflation that the ECB currently attempts to combat . In this sense the difference with the United States is blatant: well learned the lessons of 1929, the country has adopted a series of extremely lax monetary policies that have contributed to quickly lift its economy, currently full employment.
The problem of the eurozone is intrinsic to the formulation of the euro. While a team of the northern European countries euro was strong, it was risky to engage in a geographically too broad and lacking in economic fundamentals political project. Therefore, the original defect of the euro is the result of an institutional decision rather than a natural monetary accession to the converging economies that wished to be associated. Because this currency area is too broad, the euro does not correspond to an optimum currency area, characterized by the free flow of factors of production and an industrial or adequate services expertise. Worse, the euro was a missed opportunity, which allowed him to Germany in a first time (and still) do not have to reevaluate the German mark, while countries in southern Europe saw their interest rates, like taking lent themselves DM.
The fragility of the concept of the single currency is seen today with astonishing evidence: the currency area is too large and disparate economies, no budgetary or tax bases, while too large, public debts have not been the subject of a minimum mutualization (ie eurobonds) except through the purchase of government bonds by the ECB . In a recently published book, he recognizes the own ex-Finance Minister Philippe Maystadt.
But beyond the misconceptions, we must ensure at all costs the cohesion of our currency. A step back would be catastrophic. Therefore, the ECB has embarked late in some unconventional monetary measures (described as “quantitative easing”) consisting in buying sovereign debt for a total amount of 60,000 million euros until March 2017. the ECB statutes prohibit direct funding to the states, because that would make your bank credit, but in reality, this sovereign debt only fleetingly passes on bank balance sheets before being acquired by the ECB . Parallel to these measures, the ECB imposes a negative interest rate (less than 0.30%) for bank deposits entrusted to it to prevent the currency created not feed hoarding on the liability of its own balance sheet.
To understand these measures, it must be remembered that the currency is both a stock and a flow. The ECB provides a stock of currency, while commercial banks create a cash flow mechanics for deposits and loans. When the flow rate decreases, the ECB must compensate by creating a stock of extra coin. It is almost a matter of communicating vessels.
The measures taken by the ECB have allowed thus giving greater fluidity monetary circuits . However, they are temporarily without having any effect on growth, and this for three reasons:
1. First of all, the issue of government debt does not create growth as it seeks to mitigate sovereign interest rates and to avoid contraction of domestic savings. Therefore, it is not clear why the fact refinance a state without productive investment plans would push growth. Over public debts, which are also increasing, it will be transformed into money supply. Therefore, monetary creation will be fueled by government borrowing. In the event that monetary easing is extended beyond 2017, the ECB balance sheet will grow at the rate of refinancing of the states themselves. Obviously, the worst would be that the European economy will not recover and that public debt continued to rise inexorably in proportion to GDP (which is my stage with the escalating cost of pensions). In this case it will inevitably resort to the ECB to refinance States, unable to secure funding via local or foreign financial institutions. The risk of insolvency of states then would the ECB, whose balance would serve to consolidate a growing share of public debt. Obviously this would be a step towards an insidious nationalization of commercial banks whose prudential supervision has also been transferred to the ECB. On the other hand it can be seen that the interdependence of states’ management of commercial banks and the ECB has increased in some unimaginable proportions some years ago.
2. Secondly, monetary creation remains momentarily frozen in bank balance sheets without coming quickly enough to the real economy in the form of credit. In fact, the economy is suffering a crisis of demand: consumption and investment are enough to push the demand for loans despite the objective factors are favorable (a weaker euro, less expensive petroleum products, low interest rates, etc.)
3. Finally, the European QE is inherently less efficient than that launched the US Federal Reserve and the US in funding from public authorities and business is done directly through markets financial, bypassing bank balance sheets. The transmission of a relaxation to the real economy is therefore more quickly and efficiently.
The work of the ECB is justified and legitimate. However, it is the opposite of the German conviction based on the financing of public debt by saving and not through money creation. And it is precisely here that the epicenter of the crisis in the Eurozone, ie lies in the lack of consensus on the modalities of monetary policy among the countries whose currencies were unified . There are two distinct schools of thought in Europe. For some, a policy of low inflation becomes a benchmark, with subsequent lethargic policy, ie deflation, characterized by high unemployment. For others, inflation should not be an obstacle, if not reached alarming levels.
However, for financial markets the real issue of 2016 will be the anticipation of ECB measures. In fact, if the conviction low interest rates could legitimately justify because of a gloomy and deflationary economic environment, the need to weaken the euro in financial markets and the inability of the European states to maintain higher interest rates on their public debts, it is unquestionable that the quantitative easing by the ECB will not be permanent (unless they end up in the path of hyperinflation). At one point, which is to be determined, the rate of monetary growth will slow. This stage match legitimate normalization of monetary policy. At that time the markets will gradually face reality. Now I do not know the extent to which markets have created a dynamic of anticipation for monetary creation based on the belief of eternal support of the ECB. In concrete terms, without growth or inflation, the announcement of the gradual end of the quantitative easing program may be a shock to asset markets. The ECB will be watching, of course, but that does not keep us from a confrontation of forecasts. And this brings us to a singular reality: markets are currently governed more by the public economy (ie the ECB and the Fed) than a traditional economy.
The other issue has to do with the accession of some countries in the north to the ECB’s policy. Recent weeks have brought to light discrepancies between Member States concerning the management of quantitative easing . Although Germany is the main beneficiary of the euro through a currency weakened for export, monetary stability is, in this country, a sacred matter, about the Lutheran worship. And the fear of Germany is that the ECB no longer the guardian of the currency to become responsible for the financing of public debt. This situation would be unacceptable to Germany, he would veto an increasingly accommodative monetary policy. This situation would inevitably lead to a breakdown of the accession of some countries in the north to the single currency. Therefore, the market optimism lies ultimately on policy coherence that preside over the management of the ECB. In 2016, the euro will for one last test of credibility: the political consensus within the ECB.
* Bruno Colmant Director of Macroeconomic Studies Degroof Petercam
The post Forex 2016: A decisive monetary year appeared first on Profits Forex.