It’s been a long time since I took up the ‘rates will stay lower, for longer’ mantra, and in that time I’ve often said that the planners will print to infinity, if they can get away with it.
But to judge by some readers’ comments over the years, I’m not entirely sure that you realise just how serious I am about all of this. Well, I’m very serious indeed.
Last week, Europe’s central bank, the ECB, came out with a rather timely reminder that quantitative easing (QE) is still very much in play. In fact, it’s been discussing the possibility of launching a QE programme of its own. And this may have profound effects on asset prices over the coming years. So when I heard it, my ears pricked right up.
With that in mind, let’s have a look at what’s going on in Europe.
The great QE relay race is just getting going
So far, the only thing keeping European planners from printing to infinity has been fear of inflation. But there’s no talk of inflation on the continent right now. On the contrary, if you annualise recent Eurostat data, then prices have been falling at a pace of 6.5% in Greece, 5.6% in Italy, 4.7% in Spain and 4% in Portugal. Prices have even been falling in the Netherlands, and France is on the cusp of another recession.
That’s why the ECB now thinks that it’s time to consider QE.
It’s all starting to look a bit like a QE relay race. The UK and the States, big proponents of QE as the financial crisis started, picked up the baton to start. Here in the UK, as the housing bubble reflated, we were able to move out of recession and QE was put on hold. And in the States, planners are now starting to withdraw QE (the ‘taper’).
But never fear, this race is far from over; the baton is currently back with Team Japan. And they’re going like the clappers.
So I’m not surprised to see the ECB limbering up, ready to take the baton shortly. Last week during the press conference that followed the ECB pow-wow, ECB president Mario Draghi even said that the committee had been discussing QE, and that they are readying themselves for “unconventional” measures.
And Draghi himself is undoubtedly motivated by a softening in approach on QE from the Bundesbank’s chairman, Jens Weidman.
This mess in Europe was always going to happen
So why is everyone softening their stance? Well, here’s the problem: the southern European nations are suffering a terrible deflation. These are the countries that went mad during the noughties, who spent too much on property and mal-investment. It was the lure of low rates and a strong euro currency that did it. Both the public and private sector feasted on debt.
And deflation is about the worst thing that can happen to them now. The onus of debt keeps growing – it’s the opposite of ‘inflating away’ debt. What’s more, there’s no credible solution to right the ship.
But this mess was always going to happen with an ill thought-out single currency. A currency union means there has to be a way of allowing money to flow from areas doing well to those not doing so well – a way of balancing the money flows. As we know, during the noughties, this was achieved by allowing the poorer regions to rack up debt. It balanced the books!
But now there’s growing trouble. Nobody wants to lend to them anymore (nor do they particularly want to borrow more). The only way for them to achieve balance is through local deflation. That way, the southern states could regain some competitiveness, increase trade, and gradually work off the imbalances.
However, that isn’t happening. While they can’t avoid falling consumer prices, nobody wants to accept falling wages. The deflation remedy therefore cannot work.
There’s only one option left for Europe: cheating
The long-term answer is to allow the crippled southern nations to bow out of currency union. But they’d have to devalue all the debt as they go, meaning massive losses for the banks currently holding said debt.
That leaves only one option: cheat.
The central bank can simply print money and buy debt from the periphery nations. And while this is definitely a classic case of treating the symptom rather than the cause, it is nonetheless an effective way of keeping the wolf from the door. It’s easily done, and that’s why it’ll do it.
Money-printing won’t help the southern states regain competitiveness, but it will probably help lift asset prices. As the holders of periphery debt receive freshly-minted cash in lieu of their bonds, that cash is spent in other investment classes (and of course, some is reinvested straight back into funding the merry-go-round of government debt).
Here at MoneyWeek we saw this one coming a mile away – we’ve been recommending that you pick up cheap European assets for years now. And now that QE is on the table, that’s looking like a very smart move indeed. If you’re not already a subscriber, try out the magazine free here.
But anyway, the QE baton is in motion. As it passes around the globe, we should expect it to push up asset prices. The central bankers don’t want to drop the baton at this stage. As I say, the ECB is currently limbering up to take its turn.
In fact, come early next year I expect it’ll grab the thing and run with it.