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