Opinion - The ECB's "Quantitative Easing"

This week the European Central Bank provided private European banks with unlimited access to funds at a low interest rate for a three-year term.  The banks responded by absorbing nearly 500 billion euros of these loans, pledging their worst assets (including sovereign debt of the southern European countries) as collateral to the ECB.  The ECB’s action staved off an imminent bank liquidity crisis in Europe, reducing one source of recessionary pressure on the European economies.  I could write a short book on the ramifications of this action, but I’ll limit this article to a few key points: first, this was an intervention of massive significance; second, it was a necessary step in the short term; and third, it does nothing to address the underlying issues and thus only pushes back the final day of reckoning.

The ECB is restricted by law from becoming the “lender of last resort” for the countries of the Eurozone, but can intervene to provide liquidity to the banking system.  By this action, however, the ECB has violated the spirit of the law by indirectly supporting the southern European sovereign debt markets, accepting their debt as collateral and providing private banks with cheap money in return.  This has transferred the risky sovereign debt from the private banks to the ECB, stabilizing the private banks’ capital situation and simultaneously driving down the interest rates on sovereign debt.  The prime directive of the ECB is to ensure that inflation does not get out of hand, but this action is a massive move toward an inflationary policy.  This is a significant change in policy as the ECB has acted to live within the letter of the law while violating its prime directive.

The private banks were brought to this crisis by the European bank regulators, who assigned sovereign debt assets a zero-risk rating.  As a result, private banks invested heavily in the debt issues of weaker Eurozone countries since their bonds offered higher returns.  (Note that the higher returns implied a market judgment that these bonds had higher risk!)  When the quality of the debt of countries such as Greece came into question, the French and German governments were suddenly faced with the possibility of domestic bank failures should Greece default on its loans.  In addition to the threat to the shared euro currency, a default would force the France and Germany to bail out their private banks.  Led by France and Germany, the European Community reacted with a series of bailouts for Greece.  Unfortunately, the imposition of strict austerity measures in Greece in return for bailouts did not address the key underlying issues that created the Greek government debt crisis.  Noting the ineffective (and counter-productive) response of the European Community to the Greek sovereign debt crisis, the bond market traders spread the crisis to the other troubled southern European countries of Italy, Spain, and Portugal.

As the debt crisis deepened, the European banks found their access to traditional refinancing (or wholesale debt) markets increasingly limited, because the banks held large amounts of Eurozone sovereign debt – the market recognized that one or more sovereign debt defaults could force many of the European banks into bankruptcy.  This withdrawal of wholesale debt providers from the European bank market forced the ECB’s extraordinary loan program to supply liquidity to the European banking system.  With the economies of Europe moving back into a recession, the loss of liquidity in the European banking system would intensify the recessionary pressures as funding for both private and public debt would contract.

One major consequence of the ECB action is the transfer of default risk on Eurozone sovereign debt from the private banks of Europe to the ECB.  Moreover, since the ECB is legally the first priority lender, this action has reduced the value of Eurozone debt held by other parties; in the event of a Eurozone government default, the ECB will be paid before other debt holders.  Thus the wholesale debt markets will now be even more unlikely to supply credit to European banks, forcing the banks to increase their future dependence on the ECB for funding.  Similarly, the private market for Eurozone government debt has become less attractive because private holders of troubled country bonds are now subordinate to the ECB.

Finally, the risk of default by the troubled Eurozone countries has not diminished; the risk has simply been transferred from the private banks to the ECB.  And the backstop for the ECB is the combined resources of the Eurozone countries; rather than bailing out their private banks, Germany and France could be forced to bail out the ECB.  Ultimately, the taxpayers of the Eurozone will have to pay the bill, either through increased taxes or increased inflation (or most likely both).

The ECB action was required to prevent the European banking system from freezing up over the next few weeks, (and the ECB will be forced to continue it in future months), but this Euro version of the Fed’s Quantitative Easing program will have many ramifications both for the debt markets and for the economies in Europe.  By printing money on this scale the risk of future inflation has risen, and the transfer of questionable assets from the private banking system to the ECB has not decreased the overall risk to the Eurozone system.  Mario Draghi chose the lesser of two evils in pursuing this course, but it’s clear that he is aware of the tradeoffs and is not pleased with having been put in this position by the incompetence of the Eurozone governments.  The ECB has kicked the can further down the street, but this has merely delayed the inevitable reckoning.

Technology: Synchronize Your Email (and more) on Multiple Devices

If you are like me, you use more than one computer plus mobile devices such as smartphones and tablets, and you likely have more than one email account.  I would often receive notice on my mobile phone of an email on my personal email account while at work.  To respond, my options were to wait until I could get to my home PC, access Verizon’s terrible web mail client from work, or use the tiny keyboard on my phone.

Then I found an elegant solution to the problem with Easy-Email.  Now I can access all my email accounts on all my computers using Mozilla’s Thunderbird email client, and the changes I make are automatically synchronized among all my devices.  (And I’m not limited to Thunderbird; I’ve also set up the solution on Outlook before moving back to the speed and power of Thunderbird.)

The gents behind Easy-Email provide guides that contain step-by-step instructions for setting up a robust, multi-computer, multi-account email solution.  Essentially, the solution employs the advanced email capabilities of Google Gmail in conjunction with the major email client of your choice to consolidate your accounts.  Gmail serves as the central repository while your email client on each computer reflects any change made to your email folders.  Note that all the email you receive or send is available on each computer you set up in the system.  That is, you can send an email from one PC and have that email available in the Sent folder on every other PC.  In my case, I can send and receive email from my work PC, laptop, netbook, and home PC on any of my four email accounts, in addition to my iPad and mobile phone.  I’ve also set up my contacts and calendar using another guide from Easy-Email with similar synchronization capabilities.

I have encountered a couple of minor issues with the system I’ve set up.  First, running your email through Google Gmail can delay incoming messages; the delays I’ve experienced have ranged from a few minutes normally to an hour or more on occasion.  Second, I have run across one strict mail server that seems to dislike Gmail and rejects random messages.  For my purposes the benefits of the email system outweigh these minor drawbacks.  Your mileage may vary.

The guides are well-written with plentiful screen shots, and the authors respond to questions on the site’s forum quickly.  The cost is minimal, so you can try it without a huge investment.  To learn more, check out the Easy-Email site at: http://www.easy-email.net/  You might find solutions to multiple annoyances you just live with today.  (Note: This article was written earlier this year for another purpose.)

Opinion - The Euro Crisis: Cause and Possible Resolutions

In the last two months, a break-up of the euro has moved from a notion derided by the European elite, to an event that seems almost inevitable.  In reality, the inherent flaws of the current Eurozone system made this crisis inevitable, and there exist only two possible outcomes: (1) the 17-nation Eurozone (EZ), or some subset, moves to complete economic union, or (2) the weaker nations begin to exit the common currency.

In the current structure of the EZ, the euro represents a basket of independent economies, some of which are stronger (e.g. Germany) and others which are notably weaker (e.g. Greece).  As a result, the Euro’s value in the world market reflects that overall mixture of strong and weak economies and provides the strong countries with an undervalued currency and the weak countries with an overvalued currency.  This has worked quite well for the core northern countries like Germany, Finland, and the Netherlands which have seen their exports increase dramatically, improving productivity and generating significant trade surpluses, to their economic benefit.  According to Austan Goolsbee, professor of economics at the University of Chicago, Germany’s exports as a percent of total Gross Domestic Product (GDP) grew from 29% in 1999 to 47% in 2008, and “its net export contribution to GDP (exports minus imports as a share of the economy) rose by nearly a factor of eight.”  Much of these exports have gone to the southern countries of the EZ.  Goolsbee further notes that in three key southern countries, Spain, Italy, and Greece, the export percentages of GDP have either increased slightly or have fallen over that time period.  Essentially, this means that industry and jobs have moved from less productive regions such as Greece to more productive regions, such as Germany.

The threatened countries share some key characteristics, including restrictive labor laws and an uncompetitive workforce, over-regulation of industry and the economy, and over-taxation, the sum of which has led to economic stagnation and high unemployment.  Exacerbating these economic fundamentals are massive welfare entitlements that are unsupportable by the slow- or no-growth economies, resulting in a ballooning debt load.  The current euro crisis began when investors realized that Greece could not possibly generate the economic growth necessary to retire their current debt, much less their massive future obligations.

Separate sovereign currencies help regulate imbalances caused by disparate economies.  For instance, over the last decade Germany’s mark would have increased in value compared to the Italian lira, lowering the competitiveness of German products and slowing Germany’s growth in exports.  Italian goods would have gained competitiveness from a properly valued currency, and the current account imbalance between the two countries would likely have been much smaller.  Italy’s debt issue would not be solved, but would be partially mitigated by the devaluing currency with the concomitant inflation reducing the value of the debt.  They would be paying off debt with ever-cheaper lira.

Under the terms of the European Union bailouts, Greece, Italy, and Spain are being forced into dramatic budget cuts and tax increases, the latter of which will retard their economies even further and force more cuts and tax increases in a vicious cycle.  This counterproductive response is illustrative of the misguided Keynesian economics professed by the EU bureaucracy, which has also added to the debt crisis through its reliance on “stimulus” programs which increases sovereign debt with minimal to no effect on economic growth.

Interestingly, Nouriel Roubini, professor of economics at New York University, predicted this situation in 2006: “ . . . if Italy does not reform, an exit from [the euro] within five years is not totally unlikely.”  He continued: “Italy faces a growing competitiveness loss given an increasingly overvalued currency and the risk of falling exports and growing account deficit.  The growth slowdown will make the public deficit and debt worse and potentially unsustainable over time.  And if a devaluation cannot be used to reduce real wages, the real exchange rate overvaluation will be undone via a slow and painful process of wage and price deflation.  But such deflation will keep real rates high and exacerbate the growth and fiscal crisis.  Without necessary reforms, eventually this vicious circle of stagdeflation would force Italy to exit [the euro], return to the lira and default on its euro debts.”  Roubini summarized his prediction: “If Italy were to exit [the euro] this effective default on domestic and external – public and private – euro debt obligation would become unavoidable.  And a sovereign nation is able to follow such policies – [euro] exit, return to national currency and effective default on euro debt – regardless of any legal or formal constraints that the [EZ] treaty imposes in terms of no exit clauses.”  That means as a sovereign nation Italy still has the ability to break the EZ treaty when they realize it is in their best interest to do so.

At the formation of the euro, Milton Friedman, one of the greatest economists of the twentieth century, noted the fundamental flaw of the structure: “The exchange rates between different currencies provided a mechanism for adjusting to shocks and economic events which affected different countries differently.  In establishing the common currency area, the euro, the separate countries are essentially throwing away this adjustment mechanism.  What will substitute for it?”  He continued: “ . . . the more likely possibility is that there will be asymmetric shocks hitting the different countries.  That will mean that the only adjustment mechanism they have to meet that with is fiscal and unemployment: pressure on wages, pressure on prices.  They have no way out . . . with the euro, there is no escape mechanism [of sovereign currency devaluation].”

Thus without a substantial change in the substance of the EZ, either the weaker countries will be forced to abandon the euro or a core group of stronger countries will abandon it for their own new common currency.  The alternative is a move to complete economic union and much greater political union: a true United States of Europe.  The current proposals of “fiscal oversight” by Brussels are, of course, wholly inadequate; at some point a non-governmental, unelected bureaucracy will be unable to force a sovereign nation into certain actions.  Once that line is reached, a country’s government or its people will balk.  In the long run, nothing short of a surrender of fiscal sovereignty to the EU by all the EZ governments can save the euro.

The dollar succeeds in the United States because the states of the Union have surrendered their economic sovereignty to the federal government.  Economically, this means that the more productive states like Texas engage in a constant transfer of money to the less productive areas (think Detroit) through the federal government.  This occurs within the various European countries now: the industrial north of Italy essentially subsidizes southern Italy.  In a United States of Europe, money from Germany and the other highly productive areas would go to the less productive southern countries.  What is uncertain at this point is whether Europe’s people are ready for this massive step.  The relatively modest bailouts thus far have already created ill will among the taxpayers of Germany, and the overall price tag of fixing the EZ’s debt issues will be an order of magnitude greater.  On the other hand, the governments and bureaucracies of the European countries are totally committed to the EU and to ever-increasing bonds among the community, so this scenario is not completely impossible, particularly if the EU manages to finesse the necessary treaty modifications and avoids plebiscites. 

To summarize, the original concept of the common euro currency was flawed from its inception as was noted by non-Keynesian economists from the outset.  The removal of the mechanism of variable exchange rates without imposition of a federal European sovereign power rendered the current crisis inevitable.  Resolution will occur either through a dissolution of the common currency or a move to a significantly stronger economic union with a surrender of fiscal sovereignty by the EZ nations to a federal entity.