Money Printing Can Halt Europe's Crisis

Ambrose Evans-Pritchard Daily Telegraph December 2, 2011

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By Ambrose Evans-Pritchard Economics Last updated: December 1st, 2011

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This will enrage many readers â?? especially the "Austrian" internet vigilantes â?? but I have to say it.

A near universal view has emerged that Europe's crisis can only be solved by governments and fiscal policy, with varying views over the proper dosage of pain.

I beg to differ. This is a monetary crisis, caused by a jejune central bank that aborted a fragile recovery by raising rates earlier this year, allowed the money supply to collapse at vertiginous rates in southern Europe, and caused a completely unnecessary recession â?? and a deep one judging by the collapse in the PMI new manufacturing orders in November.

Needless to say, drastic fiscal austerity is making matters a lot worse. You cannot push two-thirds of the eurozone into synchronized fiscal and monetary contraction without consequences.

Note that five-year break-even spreads have dropped below zero for Italy, meaning that markets are now pricing in outright deflation. For a country with public debt stock of 120pc of GDP, that is a death sentence.

Here is the latest Italian money chart from the Banca d'Italia:

The break-evens on Germany are around 0.90

The eurozone economy is in imminent danger of crashing into deflation, bringing down the whole interlocking edifice of sovereign debt and distressed lenders. And bear in mind that Europe's bank nexus â?? including the UK, Swiss, Scandies â?? is â?¬31 trillion. Big stuff.

This crisis can be stopped very easily by monetary policy, working through the old-fashion Fisher-Hawtrey-Friedman method of open-market operations to expand the quantity of money, ideally to keep nominal GDP growth on an even keel.

This does not solve the 30pc intra-EMU currency misalignment between North and South, of course, but it quite literally "solves" the solvency crisis for Italy and Spain. They would not be insolvent if the ECB had not driven them into depression by letting their money supply implode.

Yes, I know there are lots of central bankers who say or think monetary policy cannot achieve these miracles. They are wrong. Of course it can. A whole generation of policy-makers have been side-tracked into cul-de-sacs like (Bernanke) creditism, or German religious theories of "expansionary fiscal contractions". (By the way, I learned in Ireland last week that the country's 1980s experience used as the poster child for that credo is based on false data. It does not validate the theory at all).

They have forgotten some basic lessons of economic history. As the Bank of England's Adam Posen put it, policy defeatism has taken over.

I have no idea whether ECB chief Mario Draghi really believes the mantra he is constrained to utter by his masters. It hardly matters. But his insistence that this crisis must be solved by governments alone â?? "a new fiscal compact" as he called it today â?? is a derelection of duty.

Yes, Article 123 of the Lisbon Treaty makes it illegal to purchase government bonds directly. The article is absurd. It is a fundamental design-flaw of monetary union.

But the ECB is already flouting the rules in the worst possible way by buying the bonds of states in trouble, and doing so incompetently at â?¬8bn a week â?? enough to scare residual bondholders by reducing them to junior creditors (below the ECB) without being enough to solve the problem. The policy is idiotic,

What they should be doing is quantitative easing, which is perfectly legal under EU treaty rules and the bank's mandate. Doesn't the ECB's twin pillar doctrine say that M3 money should be growing at 4.5pc? Well it is not doing so. It contracted in October, month-on-month. So get on with it.

The crisis can undoubtedly be halted immediately by the ECB. The bank can reflate Club Med off the reefs. It chooses not to act for political reasons because this mean higher inflation for Germany. That is the dirty secret. Everybody must be crucified to keep German internal inflation under 2pc.

By the way, I find the market exuberance since the Fed-BoJ-ECB-et al currency swap to be very odd. Spanish 10-year yields are down 100 basis points.

"Yesterday's coordinated central bank intervention was like the captain of a transatlantic flight coming on the intercom to tell us that, while three of the four engines have failed, the remaining one might get us to our destination," said Steen Jakobsen from Saxo Bank.

"The central banks are now the only source "â?? or engine "â?? of funding for banks. Yes, it means we now have even more guarantees of cheap money/liquidity in the system, but it's still a scary, one-engine plane. The central bank liquidity is the one engine, while the private market that used to be the other three engines, has seized up and stop functioning."

"French banks lost more than â?¬120bn of funding in the short-term wholesale market from the US over the last month, and the duration of the funding fell from an average of 44-days to less than 5-days."

Quite.

What are markets thinking? That a joint EFSF-IMF bazooka will soon be ready with â?¬1 trillion in rescue power? Or that Chancellor Angela Merkel is about to cave on Eurobonds and ECB stimulus? That the ECB footsoldiers will mutiny against the mighty Bundesbank?

No doubt something will come out of the EU's December 9 summit (with a lengthening of ECB tenders to two years and easier collateral rules, coming soon), but the evidence of a revolutionary break-through is scant so far. I suppose the flirtation of the Austrian, Dutch, and Finnish finance ministers with the dovish camp is a notable shift, but Merkel was still saying "Nein, Nein, Nein" yesterday.

Clearly a lot of investors think that Wednesday's central bank drama is a sign that something big is starting, that authorities of Europe and the world "get it" at last.

Well, I'm sorry. The world gets it OK, but Germany does not, and nor does the ECB.

Tags: Bank of England, euro, European Central Bank, eurozone, eurozone crisis, financial crisis, Germany, italy, money printing, Money supply, qe, quantitative easing, recession, US Federal Reserve

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