The ECB’s Latest Big Mistake
One of the great mistakes among economists is to receive the measures of central banks as if they were the revealed truth. It is surprising and concerning that it is considered mandatory to defend each one of the actions of central banks. That, of course, in public. In private, many colleagues shake their heads in disbelief at the accumulation of bubbles and imbalances. And, as on so many occasions, the lack of constructive criticism leads to institution complacency and a chain of errors that all citizens later regret.
Propping Up the Status Quo
Monetary policy in Europe has gone from being a tool to help states make structural reforms, to an excuse not to carry them out.
The steady funding of deficits of countries that perpetuate structural imbalances has not helped strengthen growth, as the eurozone has seen constant GDP estimate cuts already before the covid-19 crisis, but it is whitewashing the extreme left populists that defend massive money printing and modern monetary theory (MMT), threatening the progress and growth of the eurozone. Populism is not fought by whitewashing it, and the medium and long-term impact on the euro area of this misguided policy is unquestionably negative.
Today, citizens are being told by numerous European extreme-left politicians that structural reforms and budgetary prudence are things that were implemented by evil politicians with malicious intent, and the message that there is unlimited money for anything, whenever and however is whitewashed by the central bank's actions.
It is surprising to hear some serious economists at the European Central Bank or the Federal Reserve say that they do not understand how the idea that money can be printed eternally without risk is spread all over the political debate when it is central banks themselves who are providing that false sense of security. The central bank may disguise risk for a time but does not eliminate it.
The Problem with Negative Rates
Greece, Cyprus, Lithuania, Slovakia, Spain, Portugal, and Slovenia are already borrowing at negative real rates. However, negative rates are not a sign of confidence in the government policies, but an aberration of monetary policy that hides the real risk. And sooner or later, it bursts.
When politicians say that negative yields reflect the confidence of markets in the country, they are simply lying. The ECB is on its way to owning 70 percent of outstanding sovereign debt in the eurozone and buys all the net issuances after redemptions, according to Pictet and the Financial Times. There is no market.
This temporary confidence in the capacity of the ECB to alter risk is only sustained if the euro area grows its trade surplus and its economic output, but mostly if Germany continues to finance it. It is not eternal; it is not unlimited, and it is definitely not without risk.
A Decade of Easy Money
Many readers will say that this is an exceptional policy due to the covid-19 crisis which requires exceptional measures. There is only one problem with that argument: that it is false.
The ECB’s policy has been ultraexpansive for more than ten years, in crisis, recovery, growth, and stabilization periods. Interest rates were cut to negative and asset purchases extended in growth and stable periods where there were no liquidity risks in the economy.
In fact, the European Central Bank has become hostage to states that do not want to reduce their structural imbalances but aim to perpetuate them because the cost of debt is low, and the ECB “supports” them. The ECB should be worried about the fact that the most radical parties, many aligned with the economic policies of Argentina and Venezuela, like Podemos or Syriza, cheer this monetary insanity as a validation of their theories.
It is no coincidence that the reformist momentum in the eurozone has stopped abruptly since 2014. It coincides exactly with the massive liquidity injections. Structural reforms and budget prudence are perceived as evil policies. Low rates and high liquidity have never been an incentive to reduce imbalances, but rather a clear incentive to increase debt.
The big problem is evident. Once in place, the so-called expansionary monetary policy cannot be stopped. Does anyone at the ECB believe that states with a structural deficit greater than 4 percent of GDP per year are going to eliminate it when they issue debt at negative rates? Does anyone at the ECB honestly believe that, after the covid-19 crisis, governments will cut bloated budgets? Dozens of excuses will be invented to perpetuate a fiscal and monetary policy whose results are, to say the least, disappointing considering the enormous volume of resources used.
The worst excuse of all is that “there is no inflation.” It’s like driving a car at 300 miles an hour on the highway, looking in the rearview mirror and saying, “we haven’t killed ourselves yet, accelerate.”
Asset Price Inflation
It is not a surprise that the eurozone has witnessed a rising number of protests against the increase in the cost of living while the central bank tells us that “there is no inflation”, but it is also, at least, unwise to say that there is no inflation without considering the financial assets that have soared due to this policy.
Insolvent countries with negative-yielding ten-year sovereign bonds is huge inflation. Rising prices for nonreplicable goods and services, which in many cases triple the official inflation rate is huge inflation. Large increases in rent and housing are not adequately reflected in official inflation. It is especially worrying when monetary policy encourages unproductive spending and perpetuates overcapacity. This means lower productivity growth, which means lower real wages in the future.
A recent study by Alberto Cavallo of the Harvard Business School warns of the differential between real inflation suffered by consumers, especially the poorest, and the official CPI (consumer price index). Take, for example, the eurozone CPI for November. The figure is –0.3 percent. There is no inflation, right? However, in the same data, fresh food rose 4.3 percent, services 0.6 percent, and the energy component fell 8.3 percent, yet no European citizen has seen a drop in the 8.3 percent on their energy bill, because neither gasoline nor natural gas or electricity (including taxes) have fallen so much.
In fact, if we analyze the cost of living using the goods and services that we really use frequently, we realize that in an unprecedented crisis such as that of 2020, prices for the middle class and the poorest layers rise much faster than what CPI shows, and that, added to the distorting factor of the enormous inflation in financial assets, generates enormous social problems.
The fact that, for now, enormous risks are not perceived—or not perceived by the central bank managers—does not mean that they are not building. Negative-yielding debt, which has reached a record $18 trillion globally, led by the eurozone and Japan, is not a sign of confidence, but rather a huge risk of secular stagnation.
When the central bank leaders argue that they only offer a tool but at the same time they give fiscal and budgetary policy recommendations encouraging “not to fear debt” and spending much more, not only does the central bank lose independence in the medium term, but it is the same as a waiter who does not stop serving you drinks, encourages you to binge and then is outraged that you're drunk.
Introducing these huge imbalances has significant risks, and they are not my speculation of the future. They are realities today. The huge disconnect between financial assets and the real economy, insolvent states financing themselves at negative rates, bubbles in housing and infrastructure assets, debt from zombie companies or junk debt with historically low yields, aggressive increase in leveraged investments in high-risk sectors, the perpetuation of overcapacity, etc. Ignoring all these factors in a monetary institution is more than dangerous, it is irresponsible.
It is not time to do everything at any cost whatever happens. It is time to defend sound money or the credibility of institutions will sink even further as the mainstream consensus chorus sings hallelujah while the building collapses.