It looks as if Mario Draghi is at last on the way to earning his nickname. Mr. Whatever It Takes, the European Central Bank’s president, launched his long-awaited quantitative easing program last week. Early indications are promising: The policy that has worked elsewhere, not least in the U.S., should now do its job in the crisis-ridden eurozone.
Three key votes are already in. Currency traders have devalued the euro by 13 percent this year—3 percent last week—and it’s likely to drift lower. Altogether good: Weak is strong. The cheaper euro will make Europe more competitive, so boosting growth-inducing exports.
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This is vital, especially for Germany, where exports account for fully half of GDP. Over the weekend, a source very close to Europe’s central bankers noted that governors view the weakening euro as “desperately needed to catch up with Japan’s aggressive devaluation.”
Even in anticipation of Draghi’s long-embattled policy, which was announced as a “go” in January, equity traders said “yes” with alacrity. European stock indices are up around 10 percent to 20 percent so far this year on the promise of improved earnings in a range of sectors—export stocks in the lead.
In a full reading of the rush into European shares, it’s two votes in one. It’s (1) for Keynesian stimulus policies as the right way forward in Europe and (2) a vote against the austerity policies for some countries that have significantly worsened the financial and economic crisis since it took hold after the 2008 cataclysm.
Two key questions arise.
First, will nations such as France and Italy backslide in an easy-money environment, sloughing off reforms they are committed to at the European Union’s behest?
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The short answer here is yes. If ever rules were made to be broken, they include the EU’s limits on budget deficits and targets for primary surpluses.
Second, now that Draghi’s QE regime is up and running, what are the implications for the U.S. Federal Reserve, which has been trying to decide when and how to end its QE program for more than a year? Fed Chair Janet Yellen is to convene the Federal Open Market Committee this week. That gathering will be key.
Short answer: With Europe now into its own QE strategy the argument for a northward turn in U.S. rates crumbles beneath Yellen’s feet. As the dollar rises precipitously against the euro, the last thing the American economy needs now is an interest rate policy that sustains the ascent.
One doesn’t want to read too much into Draghi’s program, by which the ECB is to purchase $1.15 trillion in sovereign bonds over the next 18 months. But in my read, it is a significant philosophic victory for Draghi and all heirs of Keynes’s countercyclical economic theory.
Nevertheless, three days after Draghi’s QE schedule went operational, Jens Weidmann, head of the German Bundesbank, and Klaas Knot, his Dutch counterpart, began warning that no one gets off the hook now on the EU’s austerity regime.
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“Cheap government financing conditions should not cause governments to believe that further reforms are not needed,” Weidmann, the austerians’ standard-bearer, asserted. Knot chimed in, “For a very long time there will be no market discipline—or very little. This means that budgetary rules have become even more important to safeguard discipline in government budgeting.”
It’s a rear-guard action. France and Italy rightly determined to exceed EU-mandated rules limiting budget deficits in January, and Brussels was forced to relent. In the Greek case it’s a straight-out charade: Even bailout sponsors acknowledge that the primary surplus targets they’ve imposed on Athens are unachievable.
One man’s backslider is another’s responsive (and responsible) administration. As argued previously in this space, if it’s a question of breaking EU rules or forcing your citizens into joblessness at the edge of poverty, you break the rules and go to work getting them changed.
This face-off is not hopeless. Weidmann was Draghi’s heckling bête noire all through the months the ECB president gathered support for QE, but he caved after a face-to-face in Draghi’s office last October.
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I see the hand of Chancellor Merkel, who is a good European just as Weidmann is merely a good German, in that resolution, and it is impossible to imagine she is not watching QE’s rollout closely. Merkel’s into policies that work, not ideology.
Draghi faces one challenge now that can’t be overlooked. As the ECB buys bonds with low to negative yields, issues with positive yields are likely to attract a lot of capital. How much of this will actually reach the real economy, where it’s needed? There’s a good chance little will, my sources in Europe tell me, in which case we’re looking at another dreary case of “trickle down” economics without much trickling going on.
As to Yellen and the future of Fed policy, the phrase Washington should be looking for is “central bank coordination.” Paul Krugman made the argument in his New York Times column just before the weekend:
“The strong dollar is bad for America…. It will weaken our long-delayed economic recovery by widening the trade deficit…. The message from the dollar’s surge is that we’re less insulated than many thought from problems overseas…. Think of the strong dollar/weak euro combination as the way Europe exports its troubles to the rest of the world, America very much included.”
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Executive summary: This is the wrong, wrong, wrong time to be toying in public places with a schedule for raising U.S. interest rates. Leave it be, wait and see, Ms. Yellen.
Another point. As a number of commentators have noted recently, the Labor Department’s remarkable job numbers, which place unemployment well below 6 percent now, customarily the desired target, have come to speak with forked tongue.
The traditional measure fails to reflect this as a top-line recovery in which a lot of workers disappear from the statistics because they’re no longer even looking for jobs. The control in this experiment: Low unemployment but still no wage gains. It doesn’t compute by the standard measure.
There’s a lesson in this for the Europeans, in my view. A solid recovery, on which a future can be built, is one that puts people to work. That’s the priority now. Draghi understands this; Weidmann and all other true-believing austerians don’t seem to.
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