January 25, 2015

Swiss Movement: Clocks Striking Thirteen

by Hal Gershowitz

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Of Thee I Sing Heading Authors“Time”, someone once wrote, “is like the rumble of distant thunder at a picnic.” And so it was last week when Switzerland heard the distant thunder and severed its tie to the Euro in anticipation of the EU’s massive Quantitative Easing venture, which is intended to spark economic growth throughout the moribund European Union. The Swiss, quite correctly, anticipating a sharp drop in the value of the Euro decided not to go along for the ride and unhinged the Swiss Franc from the Euro zone currency. No longer would Switzerland maintain its artificial ratio of 1.20 Swiss Francs to the Euro.

Almost everyone is following the script written by European Central Bank (ECB) Chief, Mario Draghi, and cheering the decision of the ECB to begin an aggressive, all-out program to buy every month (with newly minted money) 60 billion Euros worth of government bond, agency and other debt as well as inflation-linked bonds and other bonds with maturities between two and thirty years  “for as long as it takes.” This infusion of money into the EU banking systems (which holds these assets) will, the thinking goes, provide vast new resources for banks to lend and, therefore, stimulate business growth.

As expected the Euro plunged in value while the Swiss franc, the US dollar, and equities in general, soared as investors dropped their Euros like hot potatoes. And that, of course, was the idea. The prospects are that the export of EU manufactured goods will pick up smartly (they are cheaper now relative to US and Swiss goods) at the expense of US and Swiss exports thereby jolting back to life EU economic growth. Norway, Japan and Austria all saw their currencies tick up over 100 basis points against the Euro as well.

Concern about deflation (constantly falling prices) clearly and properly (at this point in time) trumps fear of inflation, which by and large is nowhere to be found. We noted, above, that almost everyone is cheering. Almost, but not everyone.

People who probably never heard of Hyman Minsky are expressing concerns as though the late, famous, economics professor who taught at Brown University, UC California, Berkeley and Washington University in St. Louis, was whispering into their ears – Beware, too much cheap money sooner or later always becomes very costly.

Minsky argued that a phenomenon that invariably pushes economies toward crisis is the accumulation of very cheap debt by the non-government sector. That’s where the 60 billion of quantitative-easing Euro’s is intended to go every month. Sooner or later, Minsky argued, too many borrowers with too much cheap debt become dependent on asset values increasing sufficiently to refinance their debt and that is the stuff of bubbles and the crises they cause. We all do still remember 2008 don’t we?

So, while almost everyone is cheering the EU’s new Quantitative Easing program, we noticed a few voices across the pond that were not so sanguine about the massive infusion of capital that is about to be unleashed.

Not surprisingly, hints of concern and expressions of caution can be heard in Europe’s strongest and most conservative economy, Germany, which has the most to lose if American-style irrational exuberance causes another bubble to burst in the future.

Many in Germany fear that infusing massive quantities of cheap money into the weaker European economies will fuel asset bubbles, as Minsky predicted always happens. Whatever motivation exists in the weaker nations to pursue needed reforms will evaporate, they fear. Specifically, the Germans worry about Greece, France and Italy. The Germans know that if these or other nations stumble, they may be the only ones left standing to pick them back up.

Speaking at the World Economic Forum in Davos Switzerland, German Chancellor Angela Merkel warned that the central bank’s loosening of monetary policy risked distracting Euro zone governments from much needed reforms and undermining an already fragile recovery.

“No matter what decision the ECB should take, we should not, as politicians, be diverted from putting in place the necessary conditions for recovery,” Ms Merkel said.

Merkel seemed unimpressed by an element of the central bank’s new policy that shifts most of the risk for the bond-buying program from the ECB to Europe’s 19 national central banks. Draghi in order to get Germany to go along with the EU’s aggressive quantitative easing program agreed to this weakening of the central bank’s role, recognizing that Germany did not want to assume responsibility for the potential losses of weaker euro zone states.

One expects that Merkel and other more conservative German thinkers worry that the “policy” to shift liability to Europe’s 19 national central banks might wind up being window dressing to sell the program, and if push came to shove most of the burden of rescue would fall upon Germany.

Clearly, Chancellor Merkel is not alone in feeling queasy about the EU’s journey down QE Lane. Conservative economist Hans Werner Sinn, head of Munich’s Ifo Institute for Economic Research, claimed the central bank’s actions were illegal because they went beyond monetary policy and strayed into state financing “through the printing presses”.

Peter Gauweiler, a well-known eurosceptic and Christian Social Union party leader, said he was already preparing to take the ECB to Germany’s constitutional court over quantitative easing. Gauweiler, who has launched a number of legal actions against the common currency, said Draghi’s risk sharing agreement with other Euro zone central banks should not divert attention from the broader “illegalities” of the program.

And of course, the sinking yields on the bonds of Euro zone countries also benefited the Portuguese and Greeks where yields on 30-year Portuguese government bonds dropped 23 basis points to 3.76 per cent, while equivalent Greek debt dropped 37 basis points to 7.62 per cent on the back of news that Greek debt could be included in the bond-buying program.

Nonetheless, the EU’s quantitative easing program may be too late to qualm fears in Greece, where today’s election just might turn the EU on its head. As we go to press, it seems all but certain that Syriza, the leftist, anti-austerity party will emerge as the winner of a hard fought election. The Greeks are frustrated with the EU and many want to return to the Drachma and dump the Euro all together. Some fear that could become a contagion that might spread to other countries with chronically weak economies. The specter of Greece’s exit from the Euro zone is no longer considered unthinkable. The Greek economy has shrunk more than 25% since 2008, unemployment hovers around 25%, and it is estimated that about twenty five percent of households live in poverty. More than 100,000 business have closed in Greece since 2008.

So this is, indeed, an historic time for the EU. Tens of billions of Euro’s are riding to the rescue of a doggedly lackluster economy on the continent. In all, a trillion new Euro’s are, over the next year, intended to prop up economic growth in Europe. Thanks to our own Federal Reserve, Quantitative Easing has become the new gold standard for lifting sagging economies out of their economic doldrums. Time, however, will tell whether all that glitters is really gold.

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One response to “Swiss Movement: Clocks Striking Thirteen”

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