Lack of quantative easing is central to the Eurozone crisis

This guest blog is written by Lindsay Thomas who is Director, Sustainable Risks Ltd and a former FSA supervison director  

The Greek crisis goes on, the Euro weakens, Cameron can conveniently continue to blame the Eurozone for his policies failures while looking tough while vetoing their attempt at coordinated action. Why has the Eurozone become the centre of this on-going global crisis? And why is Greece the centre of attention?

Virtually all the world enjoyed the binge on vast liquidity and artificially low interest rates for too long. Greece is as central to this crisis as Northern Rock was to the failure of Lloyds and RBS – its small but just came first. This crisis, it’s the same one since 2007, is a global crisis – government, corporates and consumers all took on more debt than they could afford because it was so cheap and so readily available. Of course, the bankers helped everyone to as much as they could and took the vast bonuses because they were so clever and successful. When it comes to total debt not just government debt  as a proportion of GDP then the Eurozone as a whole is a poor third to the US in second and the UK well out front. So why is the Eurozone the centre stage of this crisis now? Is it basic flaw in the Euro project?

The Eurozone certainly has all the standard symptoms of advanced economies in this crisis – high debts and overpriced assets leading to insolvent banks. Well, there are flaws as they recognise and the straightjacket of a currency union has its disadvantages (the Euro gold standard) but the biggest cause for the Eurozone being so different to the US and UK is Quantitative Easing.

I describe QE as taking methadone to get us off the heroin of too much liquidity and too low interest rates. Our methadone in the UK has been £275 billion of printing money to have even lower interest rates and even higher liquidity. Brown correctly persuaded others at least to boost their economies, if not adopt QE, to avoid the cold turkey of the immediate shocks of waking up to a heroin addiction.  Methadone allows one to plan and progressively withdraw the drugs. The US adopted the same approach to the tune of $1.25tn.

But still why is the Eurozone the centre of the crisis if it had a lower debt to GDP? The answer lies in both the structure of the Eurozone and the attitude of the ECB. The Eurozone has not undertaken anything like full scale QE until just before this past Xmas when it started with a long term €500bn loan facility.  This is because the ECB does not have a mandate for propping up countries (QE was completely unforeseen when the mandate was created) and the ECB fears that QE, with it inflationary implications etc, amounts to debasing the currency and therefore should be avoided at almost any cost. A new head of the ECB has changed the attitude recognising ‘any cost’ is what they had reached. Expect the ECB to undertake at least another €1tn set of three year lending.  Now the ECB is undertaking a form of QE you will see panic in the Eurozone government bond market subside as it did forUK and US.

In summary, the ECB backed by Germany and France, bravely or foolishly, decided to go cold turkey to force as much political alignment as possible before they reluctantly took the methadone.

Whether it will promote sustainable growth is quite another matter. Getting off methadone ( I am no expert on that) will, in a financial sense, require rebasing asset values, deleveraging in the retail, corporate and Government debt (not all at the same time), allowing interests rates to rise but most of all reaching agreeing on all this between the world major economies alongside trade and currency coordination. Something Cameron does not find so convenient politically and his ‘being first to rush for the exit’ strategy brings failed captains of another type to mind. We should stick withEurope- being part of a collective solution not going it alone recognising we have achieved very little ourselves yet and we need all the friends we can get.

2 Comments

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2 responses to “Lack of quantative easing is central to the Eurozone crisis

  1. I think some very important points have been made here.

    Merkel has in fact learnt the wrong lessons: often Germans are terrified of QE because it accompanies their own hyper-inflation: but the real lesson is that hyper-inflation, at least when it became non-sustainable, was the result of trying to force the Germans to pay up unrealistc reparations, compare the way the Germans are trying to make the Greeks pay up unrealistic debts from wrongly joining the Euro.

  2. Joe Blow

    The Eurozone problems are structural and until there a dose of reality and these are addressed then there is no way that Cameron should do anything other than “rush to the exit”. The Eurozone problems are unique. The problems are not just about excessive government and private debt but more importantly massive differences in efficiencies of northern and southern economies leading to huge and persistent trade imbalances, If the Eurozone is insistent that all should remain within the eurozone, massive and perpetual capital transfers will be required from the rich north to the weak south. There is no indication that this will be acceptable to the Germans, Dutch, etc. As these imbalances remain, the southern economies will be constantly indebted to their northern neighbours, governed by strict austerity measures imposed upon them from outside. Unlike with freely traded currencies, within the euro there is no way that Greece, Spain, etc can adjust their economies to make them competitive and there is no incentive for outside investment. The adoption (or not) of QE under these circumstances is irrelevant as this will only change the value of the euro vs the USD or JPY. It does not change the relative value of assets within the Eurozone and therefore the relative attractiveness of one country versus another. The proposed policies of tax harmonization and budget controls just makes the position even worse. Until and unless the Eurozone address the central unique problems that they face then Cameron is quite right not to participate. The value of sterling has fallen and may fall further but at some point it will reach a level which both restricts imports and promotes inward investment.

    Lindsay Thomas article by focusing on QE misses the key issues