January 26, 2015
Two major and interrelated events occurred on Thursday. The first was an Italian coup d’état at the heart of the German monetary establishment in Frankfurt.
The second was a changing of the guard in Riyadh, with the death of King Abdullah in Saudi Arabia. It remains to be seen which event will have greatest impact on your life.
Let’s look at the Italian ambush in Germany first. Thursday was the day when Germany realised it doesn’t call all the shots. It no longer sets the ECB agenda. The ECB is not a multilingual version of the Germans’ beloved Bundesbank.
After all the monetary foreplay of recent years, Germany is now in bed with all sorts of deviants – the Greeks, the Spanish, the Italians – who are quite prepared to engage in unnatural financial acts for their own pleasure, and poor old Germany can only hold its nose and go along with it.
For the uptight German monetary prudes, the “unnatural act” is printing money. The Italians, Spanish, Greeks and Irish are now being allowed to experiment in a way that would make the average German blush.
For German people, money is considered a “public good”, like fresh air. It should be protected by treaties and, like the environment, money should never be interfered with. This is the Weimar legacy and obviously the memory of Hitler who looked upon treaties as pieces of paper to be broken at will. Germany never wants to do that again.
But for the rest of Europe, money is, in contrast, regarded as a “tool” to be used in a crisis to lever the economy onto a different growth path. So if there isn’t enough money in circulation, you print more of it.
This is what the Italian Mr Mario Draghi is doing, as Italians always do in a crisis – he’s printing money.
He’s not actually turning on the printing presses, but he is giving the banks much more capacity to lend. It is up to the banks now to use that money – €60 billion a month – that Mr Draghi is giving them. If they do start to lend, it’s going to make a huge difference.
So the banks have to become the spigot rather than the bottleneck.
It worked in the US, maybe because America has an inherent ability to reinvent itself economically. The Americans believe in the words of Martin Luther King: “The extreme urgency of now.” Does Europe?
The way we will know if this QE is successful is if we see, over the next few months, banks throwing money at consumers and investors to either buy or invest.
It means hearing ads on the radio and TV offering credit, getting letters through the post and having car companies lobbing finance at us. If you see this, then the policy is working.
Our world will have to feel like 2002-2008 again. This may not sound too sensible given what we’ve been through, but that’s what is going on.
The main impediment to this policy working is the fact that there is still too much debt in Europe, which hasn’t been dealt with.
A cynic might say that without debt forgiveness or debt restructuring we are papering over the cracks and all we have is a policy where bust banks lend to bust governments with “made-up” money.
If debts – both national and personal – aren’t dealt with, people will have too much debt and won’t be prepared to borrow and the banks will have too much bad debt and they won’t be willing to lend.
Some form of debt relief would make quantitative easing (QE) much more likely to be successful. This is exactly what Syriza wants in Greece and it is an entirely logical move. This is not an extreme position but is straight out of the most orthodox economic textbook.
Without debt relief, it is hard to see QE working as well as it did in the US, where it was combined with debt relief, a fiscal expansion and massive early bank recapitalisation.
But it is a start.
The reason it’s a start is because deflation is stalking Europe and the authorities have to act. This is where our friend in the desert comes in.
Look at the chart showing the collapse in the price of oil and the collapse in the euro against the dollar. They almost move in tandem.
Why is this? It is because a fall in oil prices drives down European prices, which in turn makes it more likely that the ECB will not hit its 2 per cent inflation target. The less likely this is, the more the Europeans will deploy QE and the more the euro will weaken.
The death of King Abdullah exposes the dead hand of the Saudi ruling family on the levers of power in the Gulf. His ten-year reign was marked by bouts of ill-health and now his 79-year-old brother Salman takes over as king, though he is suffering from possible dementia himself. If anything sums up the sclerotic nature of the world’s most important energy supplier, it is this hereditary vice.
The Saudis are intent on keeping the price of oil low for some time.
Current turmoil in global oil was triggered the moment it became known that Saudi Arabia had decided to steeply discount its crude.
This was to show America and its so-called shale revolution who’s boss. It was also a reaction to America’s increasing cosiness with Iran, Saudi Arabia’s enemy in the region. Saudi oilfields are profitable at much lower oil prices than anywhere else.
All this compromises the ECB’s job which is about getting the price of things to move up, not down. If the problem is deflation, the solution is inflation. And of course, when there are huge debts, if the price of everything is falling, then income is falling. And this means that debt expressed as a percentage of income is rising.
All this means that the manifesto of the so-called radical party in Greece is the only one that makes sense in today’s Europe. But you’d never think that from the mainstream commentary or from the insults being hurled at Syriza by the European elite.