The European Central Bank’s new quantitative easing program may end up pushing liquidity into the wrong economy: the United States. This may be beneficial for the euro area in the short run as the money that flows out of Europe pushes down the value of the euro relative to the dollar and as the capital inflows into the United States fuel U.S. demand for European exports. To give you a sense of how strong this effect is likely to be, I am pasting a recent history of the euro-dollar exchange rate that dates back to the start of the Greek sovereign debt crisis in January 2010. This data is provided by the Dutch national bank.
Viewed from the United States – or, maybe better, from an American perspective – the Greek elections highlight the problem of moral hazard in Europe. This is not a normal problem you would expect to arise from a democratic contest. ‘Moral hazard’ describes a condition where one party takes on excessive risks because they believe, whether rightly or wrongly, that any negative consequences can be shrugged off onto someone else. The classic example is a borrower (or a banker) who takes on too much debt and then walks away when it proves unsustainable. When we talk about elections, it is hard to see how this situation might arise. Voters can vote irresponsibly, but they are likely to bear the consequences of their own foolishness.
Republicans will remember President Barack Obama’s 2015 State of the Union address for the many veto threats it contained against legislation to reverse the affordable care act, to restart the deportation of illegal immigrants, to weaken banking regulation, or to impose new sanctions on Iran while negotiations are still ongoing. Democrats will remember those commitments as well, but they will also focus on the President’s promise to promote more equitable growth, to create new jobs, to provide greater access to childcare, to reduce the cost of higher education, and to protect the environment.
A number stories in European financial markets last week are connected by increasing concerns within the investment community about what Europe’s future has in store. Swiss central bankers abandoned their currency peg, Greek commercial bankers asked for emergency liquidity assistance, and German economists raised questions about the deterioration of Italy’s position within the Target2 system.
Worse, each of these developments feeds into new uncertainties — about whether other countries will follow Switzerland’s example or take preventative measures to lower the market pressure on their national currencies, about whether Greek banks will experience an accelerating run on their deposits now that their liquidity has been questioned, about whether the German government and the Bundesbank will increase the pressure for restraints on any ECB program for quantitative easing, and about whether the Italian presidential elections will further undermine international confidence in the Italy’s banks.
The euro area is already in crisis; European policymakers are just reluctant to admit that fact or to act accordingly. That is the punchline I want to deliver. It is a hard line to sell. We tend to think of moments of ‘crisis’ as moments when the signs of distress are all around us. It is a towering inferno, a crashing airliner, a listing ferry, or a hostage situation. It is hard to see evidence of any such disaster scenario unfolding in Europe at the moment. Neither the Greek parliamentary elections nor the Italian presidential elections would qualify; we are not in 2012 anymore, or even 2013 for that matter. This time is different.
For about thirteen months from May 2012 to June 2013, I wrote a weekly column for Oxford Analytica called ‘Europe Compass’. The idea was given to me by Nader Mousavizadeh and nurtured by Sarah Naimark, Stephanie Hare, Michael Taylor and Graham Hutchings. It was arguably the best learning experience I have had. Palgrave Pivot agreed to publish the best of those essays in a slender volume called The Year the European Crisis Ended. That volume came out in June 2014.
Given the way things are going at the moment, it is probably time that I updated that analysis. The news today makes for depressing reading. The European statistical agency, Eurostat, has just published flash estimates for euro area inflation last December and they show prices contracting for the first time since 2009. The ostensible reason for the low rate of inflation is the collapse in energy and food prices; consumer prices actually rose slightly in the euro area once those factors are taken into account. Nevertheless, inflation is still below one percent on an annualized basis and market participants are not expecting that number to creep up any time soon.
The pressure is building on the European Central Bank (ECB) to craft an appropriate response. This is not a sudden development. ECB President Mario Draghi has been struggling to get a handle on this crisis since he came into office in November 2011. Along the way, he has given us a number of historic soundbites. The July 2012 commitment to do ‘whatever it takes‘ to safeguard the euro is only the most important. His August 2014 speech at Jackson Hole is not far behind. Although the speech was ostensibly about unemployment, Draghi closed by looking at the threat of falling prices (or deflation). He noted that market expectations for medium price increases were stable but there is always the risk that they might become unmoored. And cautioned about the implications of a prolonged period of low inflation. He concluded that part of the analysis by stating that: ‘The Governing Council will acknowledge these developments and within its mandate will use all the available instruments needed to ensure price stability over the medium term.’ This is just another way of say ‘whatever it takes’ all over again.
Now the markets are expecting ‘whatever’. You can see that in the historic lows in the value of the euro against the dollar. Market participants have priced in some kind of decisive action. Maybe ‘decisive’ is too strong, but they have certainly priced in something. We will have to wait until the Governing Council meets on 22 January to see what that something is. We may even have to wait longer.
Meanwhile Greece is headed to the polls and Italy faces a presidential election. Populist, anti-austerity, and anti-euro parties are on the rise in various parts of the European Union — both inside and outside the euro area. Ukraine is in turmoil and Russia seems intent to continue its policy of destabilization. And that is not to mention the various problems in the Middle East and North Africa. It is hard against that backdrop to imagine that the European crisis actually ended. It is time for me to start learning again.
I will try to repeat the pattern of writing one longish (roughly 1200 word) essay a week so long as I can maintain the discipline. The essays will cover macro-economic and macro-political developments in Europe. Sometimes I will also look elsewhere. But I am well aware of my limitations.Follow @Erik_Jones_SAIS