Don’t count on ECB QE in the near term…

While investors around the world may have found the ECB’s inaction in recent months in the face of growing deflationary signs frustrating, it is probably fair to say that the governing council certainly found the latest inflation data to their relief and vindicated their current policy stance. March’s 0.5% HIPC reading actually rose to 0.7% in April and so provided some extra thinking time on Mario Draghi’s front as to whether he should unfold further “unconventional” measures of monetary policy or not.

Over the last few weeks it appeared to many that the ECB has been indicating that it was prepared to adopt a more unconventional approach in pursuing its 2% inflation goal as the central bank had been concerned with the growing deflationary risks as we can see in the chart below and the seeming ever increasing Euro.

While the ECB members have been vocal about potential quantitative easing, the truth is that they may not be willing to actually pull the trigger, particularly so now after the latest inflation data.

The main goal defined for the central bank is to keep inflation near the 2% target but, in a marked difference to the route the Fed has pursued, without monetising member states debts. Implementing an asset purchase program similar to what has already been unfolded in the US and Japan is more or less impracticable in Europe, at least under the current rules and legislation. At the same time, even if legislation could be surpassed, there is still massive opposition to such a policy coming from core members Germany and France.

The Weimar state in the early 20^th century was one of the worst episodes ever experienced by the Germans, and who ninety years later, are still daunted by the hyperinflation ghost. The Germans will very likely make use of their pivotal influence on the ECB council to prevent any policy design that is tailored at creating inflation directly.

Peripheral Europe In particular is continuing to pay the price of deleveraging and is reeling from the costs of a currency war in which many countries such as Portugal, Greece and Spain have been unwilling participants. While Europe has been imposing tough austerity measures to achieve fiscal consolidation and avoiding the monetisation of debts and manipulation of its own currency, others like Japan and the US have been playing the opposite game. Even though already being highly indebted, they opted for the easy option of printing money and the debts have kept rising. While the ink is running out in the US with the current tapering program, Japan has a massive storage of replacement cartridges which will likely threaten price stability in Europe in the medium run. Eurozone exporters will find it increasingly difficult to stay competitive as the Euro rises and they may have to impose lower wages which of course has severe social consequences. These short-term costs may turn into huge long-term benefits at the expense of the printing countries.

Ben Bernanke said a few years ago that the benefits that come with monetary easing outpace its risks. A cynic would say that he would say that wouldn’t he?! Five years later after implementing his unorthodox policies, the FED has started cutting back on the program. The US economy is growing at a stronger pace than Europe, has a much lower unemployment rate, and, at face value anyways, seems to be getting back on track. At least that is the image policymakers in the U.S want us to see. Of course, there is another side to this equation…

US debt is continuing to pile up with ominous signs on the horizon. Last year the US government actually shutdown due to the Congressional impasse on the debt ceiling and the country almost experienced the unthinkable; that is defaulting on its debt obligations. While Europe is worried (probably too much) about its own huge amounts of debt that accumulated over the years, the US in contrast ploughs on in its own debt accumulation. They are currently able to do this due to the dollars unique “reserve currency” status but this situation won’t last forever as people will eventually realise that they are using money that is backed by the “faith” of a bankrupt country.

According to last week’s FT, China will surpass the US as the number one economy at the end of this year. According to IMF numbers, that would just happen in 2019. The main difference between the two databases is that the ICP uses PPP measures instead of exchange rates which results in a more realistic indicator of a country’s wealth. Adding to this, the ICP upgraded several emerging economies with India that holding 3rd place under this methodology. With all these emerging markets growing so fast and the FED still devaluing its currency even with the taper in motion, it seems to me that we are moving ever nearer to the day where a different trading currency other than the dollar is used to underpin international trade. At that time, the FED will finally start understanding what the long-term negative effects deriving from monetary easing are. The Euro is currently well positioned as a dollar replacement and perhaps goes a long way to explain the ongoing resilience of this currency.