ECB Spawned Financial Dependency That’s Now Very Hard to Undo

Yves here. Many readers will object to the claim at the top of the post that Europe is growing. It is important to keep in mind that by the low bar the officialdom has set for economic performance, Europe is indeed growing, but hardly enough to need to worry about putting on economic brakes.

Michal Kalecki provided a brilliant analysis of this dynamic in 1943. I urge you to read his seminal essay in full if you haven’t yet. Notice that he predicted both negative interest rates and calls for income guarantees. Key sections:

In should be first stated that, although most economists are now agreed that full employment may be achieved by government spending, this was by no means the case even in the recent past. Among the opposers of this doctrine there were (and still are) prominent so-called ‘economic experts’ closely connected with banking and industry. This suggests that there is a political background in the opposition to the full employment doctrine, even though the arguments advanced are economic. That is not to say that people who advance them do not believe in their economics, poor though this is. But obstinate ignorance is usually a manifestation of underlying political motives….

The reasons for the opposition of the ‘industrial leaders’ to full employment achieved by government spending may be subdivided into three categories: (i) dislike of government interference in the problem of employment as such; (ii) dislike of the direction of government spending (public investment and subsidizing consumption); (iii) dislike of the social and political changes resulting from the maintenance of full employment….

What will be the practical outcome of the opposition to a policy of full employment by government spending in a capitalist democracy?…

In current discussions of these problems there emerges time and again the conception of counteracting the slump by stimulating private investment. This may be done by lowering the rate of interest, by the reduction of income tax, or by subsidizing private investment directly in this or another form. That such a scheme should be attractive to business is not surprising. The entrepreneur remains the medium through which the intervention is conducted. If he does not feel confidence in the political situation, he will not be bribed into investment. And the intervention does not involve the government either in ‘playing with’ (public) investment or ‘wasting money’ on subsidizing consumption.

It may be shown, however, that the stimulation of private investment does not provide an adequate method for preventing mass unemployment. There are two alternatives to be considered here. (i) The rate of interest or income tax (or both) is reduced sharply in the slump and increased in the boom. In this case, both the period and the amplitude of the business cycle will be reduced, but employment not only in the slump but even in the boom may be far from full, i.e. the average unemployment may be considerable, although its fluctuations will be less marked. (ii) The rate of interest or income tax is reduced in a slump but not increased in the subsequent boom. In this case the boom will last longer, but it must end in a new slump: one reduction in the rate of interest or income tax does not, of course, eliminate the forces which cause cyclical fluctuations in a capitalist economy. In the new slump it will be necessary to reduce the rate of interest or income tax again and so on. Thus in the not too remote future, the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy. The same would arise if it were attempted to maintain full employment by stimulating private investment: the rate of interest and income tax would have to be reduced continuously.

In addition to this fundamental weakness of combating unemployment by stimulating private investment, there is a practical difficulty. The reaction of the entrepreneurs to the measures described is uncertain. If the downswing is sharp, they may take a very pessimistic view of the future, and the reduction of the rate of interest or income tax may then for a long time have little or no effect upon investment, and thus upon the level of output and employment….

This state of affairs is perhaps symptomatic of the future economic regime of capitalist democracies. In the slump, either under the pressure of the masses, or even without it, public investment financed by borrowing will be undertaken to prevent large-scale unemployment. But if attempts are made to apply this method in order to maintain the high level of employment reached in the subsequent boom, strong opposition by business leaders is likely to be encountered. As has already been argued, lasting full employment is not at all to their liking. The workers would ‘get out of hand’ and the ‘captains of industry’ would be anxious to ‘teach them a lesson. Moreover, the price increase in the upswing is to the disadvantage of small and big rentiers, and makes them ‘boom-tired.’

By Don Quijones, of Spain, the UK, and Mexico, and editor at Wolf Street. Originally published at Wolf Street

As the Eurozone economy continues to grow, pressure is rising on Europe’s biggest bond buyer, the ECB, to withdraw from the market, a process it has already begun. No one believes that more than the head of Germany’s Bundesbank, Jens Weidmann, who recently told Spanish newspaper El Mundo that the ECB should soon set a date to end its multi-trillion euro asset-buying program.

”The prospects for the evolution of prices correspond to a return of inflation to a level sufficient to maintain the stability of prices,” he said. “For this reason, in my opinion, it would be justifiable to put a clear end to the buying of bonds by establishing a concrete date (for ending the program).”

Weidmann, who is hotly tipped to replace Draghi in 2019, has been one of the most vocal critics of the ECB’s QE program.

“Central banks have become the largest creditors of nation states,” Weidmann noted. “With our program of bond purchases, the financing conditions of Member States depend much more directly on monetary policy than in normal times. This could lead to political pressure on the ECB board to maintain lax monetary policy for longer than would in fact be justified from the perspective of price stability.” 

Though it has lowered its asset purchases to €30 billion a month, the ECB has pledged to keep buying until at least September. But with the Eurozone economy growing faster than it has since the crisis and inflation comfortably above 1%, the ECB is widely expected to wind down the program thereafter. “If the economy continues to do so well, we could let the program run out in 2018,” ECB rate-setter Ewald Nowotny told Sueddeutsche Zeitung.

But what would that mean for the countries, companies, and banks that have grown to depend so much on the ECB’s extraordinary largesse?

Right at the front of the monetary welfare queue is the government of Italy, which is saddled with one of the biggest public debt mountains on the planet. The ECB now holds €326 billion of Italian bonds, an amount that far exceeds the €246 billion increase of Italy’s gross national debt since 2012, when this program started. The ECB’s binge buying of Italian debt has enabled just about every other investor in the market, including Italian, French and German banks, to offload some of their holdings.

As the ECB cuts its purchases of Italian bonds, those investors will have to come back into the market in a big way; otherwise the yields on Italian bonds will begin soaring, driving up the costs of funding for the government. This will be a huge, perhaps even insurmountable, problem for a country whose economy is still 6% smaller than it had been before the global financial crisis of 2008.

But the problem of mass financial dependency in Europe created by the ECB’s unconventional monetary programs extends far beyond national governments. As the IMF warned in its latest note on Spain’s financial system, Spanish banks have also grown dangerously dependent on ECB liquidity in recent years, with 6% of their total funding now coming directly from the central bank’s coffers

In this case it’s not the ECB’s QE programs but rather its myriad TLTRO programs, clocking in at almost one trillion euros, that have fuelled the dependency. Many banks used the virtually free loans the ECB offered them for carry-trade purposes, acquiring 2-3% yielding Spanish bonds and pocketing the difference. According to the IMF, by the close of 2016, one entity (whose identity it refuses to disclose, for obvious reasons) relied on ECB funding for 17% of its liquidity needs.

Although the report’s authors acknowledge that overall Spanish banks’ finances have improved in recent years, they have serious reservations about the banks’ capacity to access sufficient funds in an adverse market scenario. They also believe that replacing ECB financing, which is virtually free of charge, with funds provided by the more expensive wholesale market could be “detrimental” to the stability of Spanish banks. There could even be “liquidity tensions” if the ECB opts to cut off the liquidity tap too fast.

Also at risk of a drastic draw down in ECB funds are the hordes of zombie companies for whom the ECB’s buying of corporate bonds and the artificial regime of low or even negative interest rates have provided a desperate lifeline. According to research by Bank of America, about 9% of Europe’s biggest companies could be classified as the walking dead — that is, companies with interest-coverage ratios at 1 or less and that risk collapse if the support dries up.

In other words, rather than helping to address the myriad systemic issues plaguing Eurozone banks, the ECB’s multi-trillion euro monetary policy measures have merely delayed the inevitable while creating a mass culture of monetary dependency at the very top of Europe’s shaky economic edifice. By Don Quijones.

Did someone say “referendum?” Read…  Switzerland too Falls Out of Love with the EU

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  1. Jim Haygood

    ‘The ECB now holds €326 billion of Italian bonds, an amount that far exceeds the €246 billion increase of Italy’s gross national debt since 2012’

    Thirty years on, Europe’s Stability and Growth Pact which set a 60% of GDP ceiling on national debt is a dusty relic.

    Italy’s debt was way over 60 percent from the get-go, so the eurocrats can’t have been serious. Now it stands at a growth-prohibiting 132 percent. “No exit,” as ol’ J P Sartre quipped. And Italy’s own countryman, Mario Draghi, sold it the rope to hang itself.

    ‘G*d d*mn the pusher man’ — Steppenwolf

    1. Eustache De Saint Pierre

      So they are going to shutdown the ECB’s corporate food bank, although I do wonder if push comes to shove which appears inevitable, whether they would allow the collapse of elements within or all of ” The Precious “, which I suppose would come under how they would react in the advent of any crisis of any size.

      In terms of the trap & at least according to Philip Mirowski’s take on Neoliberalism, there are going to be large elements of society who will find themselves in increasingly worsening conditions, which makes me wonder how bad it would have to get for the animal in the trap to be forced to chew off a part of a limb in order to escape, which in any case thus wounded would probably leave them as easy prey to vultures & other financial predators, & dare I say, military intervention, especially if they refused to pay the toll, bail or whatever – wild imaginings I sincerely hope, but it has rhymes in history.

      1. JBird

        So they are going to shutdown the ECB’s corporate food bank

        The American Powers That Be consider giving our “job creator” corporate overlords, especially the financial sector all the economic food stamps that want, never mind need, while considering giving even unemployed families with children actual food stamps enabling the parasitic Deplorables.

        People as a whole have an innate sense of fairness, which often is disrupted, as it was lately, but as with the French and Russian Revolutions, will come forth. That and having nothing but desperation left.

        …it has rhymes in history.


    2. Anonymous2

      I confess I am not persuaded that 132 percent is really growth-prohibiting. I have long thought that the 90% ceiling – which I assume lies behind your comment – was a bit of data mining by Reinhart and Rogoff. In my own country (the UK) many of the best years of growth came shortly after WW2 when the national debt was through the roof, way above 90% IIRC.

      Mind you, I think the best solution for Italy is for Germany to open the taps and spend. Not that that is going to happen in a hurry (or even, I fear, in my lifetime).

      I do accept that a significant fiscal stimulus is not going to come from the Italian government.

      1. Eustache De Saint Pierre

        Fiscal stimulus would be Keynesian which is a total antithesis to Neoliberals & the Ordoliberal Germans feel pretty much the same way about it. Italy like Spain & France is as Mark Blythe put it stuck in the trade deficit trap being crushed by the huge German surplus, a reason why the not so long ago celebrated French workers for being the world’s most productive, are being screwed.

        Here is an article from Jaques Sapir a French economist which uses a 2015 IMF report which highlights the problem particularly in a chart named: “Magnitude of exchange rate appreciations / depreciations in the event of the dissolution of the euro zone “.

      2. Don W

        Referring back to the Thomas Herndon, Michael Ash, and Robert Pollin paper on Reinhart and Rogoff that pretty much found that the correlation lost statistical significance, and is certainly not 90%.

        I had to look back to an article on the Amherst paper to refresh my recollection.

        “differences in average GDP growth in the categories 30-60 percent, 60-90 percent, and 90-120 percent cannot be statistically distinguished.”

        Maybe over 120% but there is little evidence and certainly not enough to be a basis for fiscal policy. Then, we have to get to the fact that even if there is correlation, causation is not addressed it is more likely that low growth causes deficits than the other way around.

        1. Eustache De Saint Pierre

          Austerity is a separate issue – a trade deficit or surplus is a matter of whether a countries trade balance is weighted more to exports or imports. The US as a major consumer has a large deficit which means it can function as a reserve currency. Germany’s large surplus means that in comparison to deficit countries especially within the strait-jacket of the the EZ means that their currency is undervalued in comparison to deficit countries – something that Trump actually got right.

          Before the EZ, deficit countries could occasionally devalue their currency in order to stay competitive, but this is not possible due to the fact that they no longer control their own currencies, their only option therefore is to screw down workers & cut public expenditure. In terms of fiscal policy I would be thinking of investment in infrastructure which is in an increasingly bad state of repair, as in for example German bridges, but the Odor / Neoliberal control of economic policy will not allow that, except for a paltry sum provided through Junker.

          There is virtually no investment in job creation or much else but rather the opposite, not to mention public housing or anything that might benefit the left behind. As far as I can tell it is as Mirowski predicted in terms of Neoliberal worship of the market with Macron in particular being the poster boy for it, something highlighted recently when he stated that France should be a ” Start Up ” silicone valley style economy.

          Now if you believe that Neoliberalism is a good thing then you should be very happy, but my belief is that it will either lead to the misery of millions who are not deemed as useful human capital, or it will lead to a probable disastrous revolt of some sort, which will likely not help those who would be desperate enough to start it.

          BTW….that article states at the start that laissez-fairre was responsible for the financial crisis, when in fact it was Neoliberal policies that were actually responsible, started by Reagan, boosted by Clinton with the baton being passed on ever since.

          1. Don W

            Yep the NeoLiberal solution is bull.

            Eurozone countries must have balanced budgets, as currently constructed. The 3% or 60% of GDP ceiling or whatever other deficit metrics they have in the Treaty is irrelevant. They are now like US states without their own currency, which means they must have balanced budgets. They can have debt but it must be paid from some revenue stream, such that the budget is balanced. Then, they have no Federal government that can spend more into states that import more from other states and spend less into states the export more to other states. As you said the only tool available is to reduce pay and cut public expenditures, but for countries like Greece my semi-educated guess is violent revolution would occur before the screws could be tightened enough to make them “competitive”.

            1. Eustache De Saint Pierre

              I have often wondered what the US would look like if it were constructed like the EZ.

              I would bet on Italy despite the huge bill they would receive, but it is just a guess & these days it increasingly appears to be a case of expect the unexpected. The tragedy for me is that as always the very many are being slowly forced into a state of desperate measures due to the fact that they feel that they have no other place to turn. Perhaps that short period of relative affluence for the many at least in the West, will turn out to have been a very short historical anomaly.

              Perhaps something will come up & I am very disappointed that the EU project appears to be turning into something not in any way resembling the feeling reflected by it’s anthem, Beethoven’s ” Ode to Joy “, a piece of music that I can no longer listen to.

              1. Don W

                My rough guess economically. California would be Germany exporting more than it imports. Alabama or maybe Kansas would be Greece.

                It is why it always makes me cringe when people bring up that blue states subsidize red states because blue states pay more in federal taxes than they get in federal spending and red states pay less in taxes than they get in spending. This is what makes the US economy not the EU where “poor” states would be like Greece and have 25% unemployment and be under crushing austerity even worse than their State governments currently do to them.

                1. Eustache De Saint Pierre

                  Thank you for that…..I thought the top dog would be California, but that was as far as it progressed.

  2. Oregoncharles

    No, Europe is shrinking, like the other land masses, because the seas are rising. Ultimately, we will have significantly less land to support the population.

    Sorry, couldn’t help myself.

  3. Anonimo2

    “Central banks have become the largest creditors of nation states,”

    And this is how it should be. In a fiat monetary system it is not necessary to have a creditor parasitic class of bondholders. They are upset because they want their free lunch back.

    Tell me, why should the state go into debt selling bonds to private creditors, who will buy these bonds with fresh money created from thin air by commercial banks? Let’s bypass this unnecessary overhead and let central banks create the money, which is what they were supposed to do in the first place.

    I wonder who is really dependent on monetary welfare, sovereign states that could create their own money or the leisure-rentier class that sucks the blood out of the economy.

    1. Don W

      “why should the state go into debt selling bonds to private creditors”

      To control interest rates and maybe as an ultra safe savings vehicle. Neither of which are required to have any relationship to the deficit.

      Per Abba Lerner’s Rules of Functional Finance.

      1) The government shall maintain a reasonable level of demand at all times. If there is too little spending and, thus, excessive unemployment, the government shall reduce taxes or increase its own spending. If there is too much spending, the government shall prevent inflation by reducing its own expenditures or by increasing taxes.
      2) By borrowing money when it wishes to raise the rate of interest and by lending money or repaying debt when it wishes to lower the rate of interest, the government shall maintain that rate of interest that induces the optimum amount of investment.
      3) If either of the first two rules conflicts with principles of ‘sound finance’ or of balancing the budget, or of limiting the national debt, so much the worse for these principles. The government press shall print any money that may be needed to carry out rules 1 and 2.

      1. Anonimo2

        You’ve got a point. Yet I would say that the 3rth point is the most important one.

        Public debt can have its uses, but it should not be used to hand the monopoly of money creation to banks nor to subsidize a parasite class of bondholders.

        Sound finance is not sound at all.

      2. Synoia

        why should the state go into debt selling bonds to private creditors


        Just create money and give to the poor, as both welfare and as jobs for creating infrastructure.

        Never bail out the banks or the rich.

  4. RBHoughton

    Italy will have to pay more for its loans. There is no other answer if ECB stops supporting the country. Its not just Italy either – the whole south of Europe is a can of worms. One in ten of Europe’s biggest companies are dead but have not laid down! A shake-out is due.

    We should listen closely to what British Shadow Chancellor McDonald tells Davos – that will be the light at the end of the tunnel. The banks and industrialists may not like it but reform cannot be postponed any longer.

  5. KPL

    Can ECB really stop bond buying under the circumstances outlined above? More likely is Draghi doing another whatever it takes act in 2019 should the going get tough. At this rate how will the ECB ever get out… killing a few zombies at a time would reduce dependency over time without creating a 2008 like crisis. Even then looks like it is a few years out before ECB can wean them all, if at all. At this rate ECB ending QE in 2017 seems to be wishful thinking.

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