When the euro was introduced more than 15 years ago it was marketed as the rock-solid currency that would beat the sterling, the U.S. dollar and the Swiss franc as the world’s safe haven for investors.
Part of the foundation for that ambitious, but not unattainable, goal was the convergence criteria that were supposed to align fiscal policy in all euro-zone countries. Those criteria, which went into effect in 1993, were elevated to constitutional status and still guide fiscal policy in the form of the Stability and Growth Pact. One of the three pillars of the pact was a ban on deficit monetization: the European Central Bank was not allowed to print money to buy up treasury bonds.
During the Great Recession the first two pillars of the Pact have crumbled; now the third one is about to fall apart as well. From the EU Observer:
The euro has begun 2015 at its lowest level in more than eight years, as markets expect the European Central Bank to present plans to buy government bonds in the coming weeks. The single currency was trading at $1.19 on Monday (5 January), its lowest rate since 2006, after ECB president Mario Draghi gave an interview stating that the bank was preparing a programme to buy up government securities in its latest bid to stimulate greater consumer demand and avoid deflation.
Unless the ECB is planning to buy bonds directly from European consumers, there is no direct connection between Draghi’s bond purchases and consumer spending. If he is hoping to depress interest rates even further and thereby stimulate consumption, then he has very little to play with. In most euro-zone countries interest rates are plunging toward zero – credit is practically available for free.
The problem is not lack of liquidity. The problem is lack of faith in the future. More on that in a moment. Now back to the EU Observer:
Speaking to German daily Handelsblatt on Friday (2 January), Draghi said the ECB was preparing to expand its stimulus programmes beyond offering cheap loans to banks and buying private sector bonds. “We are in technical preparations to adjust the size, speed and compositions of our measures in early 2015,” said Draghi, who will convene the next meeting of the bank’s Governing Council, where the support of a majority of its 25 members would be needed for a decision to be taken, on 22 January.
That will be four days before the Greek elections, which could bring the euro-secessionist Syriza to power. Syriza is a leftist hard-liner party with Venezuela’s defunct president Hugo Chavez as their political and economic role model. They would not think twice of reintroducing the drachma if they had enough political clout to do it.
By promising to buy up government bonds, the ECB could make a direct appeal to Greek voters – or at least to an incoming Syriza prime minister – that the ECB will buy all their government debt if only they choose to stay in the currency union. That, in turn, will basically give a new Syriza government the bargaining chip they need vs. Brussels to end austerity and return to the spending-as-usual policies that reigned before the Great Depression.
Precisely the situation the Stability and Growth Pact was supposed to prevent.
And again, as always, there is the change in tone among forecasters – the same kind of change that has become so frequent in recent years:
Draghi added that the risk of negative inflation had increased … Eurostat’s monthly inflation data to be published on Wednesday is likely to show that prices fell by 0.1 percent in December, the first decline since 2009. … Market analysts are forecasting another difficult year for the single currency bloc, predicting that the euro will continue to weaken against the dollar over the course of 2015, as a result of a combination of very low inflation and weak economic performance. … The eurozone economy is forecast to have grown by a mere 0.8 percent in 2014, and to grow by a meagre 1.2 percent in 2015, well below the US.
Unless there is a radical change in fiscal and welfare-state policies across the euro zone, its GDP won’t even grow by one percent for 2015.
A bond-buying program by the ECB won’t change that. All it will do is allow governments to return to deficit spending, which is not a desirable alternative to the austerity policies of the past few years. Europe needs structural reforms in the direction of free markets, limited government, low taxes and cheap energy. Nothing else will help.