ONCE again two news stories broke within hours of each other which will have a major impact on the global economy.
European Central Bank (ECB) President Mario Draghi announced the launch of an open-ended, expanded monthly €60-billion ($70 billion) private and public bond-buying program lasting until at least 2016.
King Abdullah of Saudi Arabia died on Friday. Seventy-nine-old Crown Prince Salman has been named successor.
The ECB will print about one trillion euros over the next year or so to buy the debt of sovereign nations and some asset-backed corporate debt held by European banks. This massive quantitative easing program is designed to increase inflation. Does anyone remember a gentler time when inflation was supposed to be an unhealthy economic condition?
The purpose of the ECB program is to bring more liquidity into the European economic system with the idea that if the ECB buys debt from the banks for cash, the banks will then loan more money (at near zero interest rates) to consumers and companies to spend. Economic activity and growth will therefore be stimulated.
The fact that this policy did not work in Japan 20 years ago–or recently for that matter–and that it has not worked in the United States is irrelevant. This time it will be different.
Saudi Arabia has been ruled by King Abdulla, first as regent to his bed-ridden half-brother and then as King, for the past 20 years. Crown Prince Salman has assumed the Saudi throne as the handpicked successor to Abdulla and presumably will continue the current Saudi policy of refusing to lower crude oil production to lift the price.
King Salman reportedly suffers a form of dementia, which means that he will fit in perfectly with most of the world’s government and economic leaders in power today.
The ECB money printing program is intended to raise prices by flooding the system with new money. Theoretically, consumers and businesses hold back on new spending if prices are going down, thinking that if they wait longer, they will buy at a lower price the future. There may be some validity to that argument.
However, the real-world fact is that when you buy debt from the banks through a QE program. It does not increase retail lending. The banks sell their debt to the central bank, take the cash, and use the money for other purposes. They buy back their stock to inflate the price, trade the stock market for their own account, and pay out generous director bonuses based on stock price increase and trading profits. They also use the new cash to loan to stock market investors who also play the market.
We know this is true based on what has happened in the US and Japan over the last years. In fact, after the ECB announcement, both the US and European stock markets were up over 1.5 percent. Buying sovereign debt is actually deflationary for it is effectively retiring the debt that is near-worthless both in terms of the interest gained on that debt and with the risk of default. It is bailing out banks, not inflating the economy.
US banks have not been lending except for loans that carry the highest possible interest rates such as consumer credit cards. Housing loans in the US have increased even paying very low rates simply because the US government is guaranteeing those loans to take away all risk. Bankers, just like everyone else, love getting free government money.
The recent move by the Swiss National Bank to allow the Swiss franc to appreciate and to no longer support the value of the euro has now been proven to be the only sensible move. Also after the ECB announcement, the euro dropped to a 13 year low.
Meanwhile we sit here at the edge of nowhere with a sound peso, a growing economy and an investment climate that Barron’s weekly financial newspaper summed up in a recent headline: “Philippines Answers Investors’ Prayers”.
I had intended to title this column “Europe goes full retard”, but that word has historically been used to label persons of reduced intellectual abilities, and is an unfair insult to them. However in this case, ‘retarded’ perfectly describes this new ECB policy.
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