By Matthew Lynn
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LONDON (MarketWatch) — The only questions left for the European Central Bank now are: How much? And how quickly? The latest price data out of the euro-zone makes it painfully clear that much of the euro-zone is slipping into deflation. Even the hawks at the Bundesbank have come around to the view that some kind of monetary stimulus is now the only option left. A blitz of quantitative easing from the ECB might or might not dig the euro-zone economy out of a hole. The evidence from elsewhere suggests that printing money stops things from getting worse while not actually making them much better. But one thing is certain. Full-throttle QE will lift asset prices around the world. The global bull market is starting to look well past its sell-by date. But the ECB is about to give it another leg — and extend the run by at least a year before the next crash comes. The evidence that deflation is taking a grip on the euro zone gets stronger with every week that passes. Last week we learned that Spain joined the list of countries in outright deflation, with prices dropping by 0.2% in March. In Germany, which is meant to be the motor of the euro-zone economy, inflation dropped to 0.9% in March from 1% a month earlier. On Monday, inflation across the euro-zone fell to an annual rate of just 0.5%, down from 0.7%. This is coming against the backdrop of an extremely anemic recovery. Even though this is the upturn, both the Italian and Greek economies are still contracting. The French economy is a heartbeat away from another recession. Ireland was the poster boy for recovery within the straight-jacket of the single currency, but a 1.5% drop in retail sales in February suggests that is not going to be sustained. Nothing in any of those numbers suggests a sustained expansion — and with retail sales falling, companies are more likely to cut prices than to raise them. Call to actionEven the hardliners on the Bundesbank are coming to the conclusion that the time to act has arrived. Last week, the Bundesbank President Jens Weidmann argued that the ECB might soon have to start buying bank assets or government debt directly in the market. The widely held view that the ECB’s mandate prevented it from printing money was wrong, he argued. “This does not mean that a QE program is generally out of the question,” Weidmann told Market News International. There’s nothing too surprising about that. Even the high-priest of monetary conservatism Friedrich Hayek warned that deflation could be as dangerous as inflation. Still, with the Bundesbank on board, the chances of the ECB launching a monetary blitz have increased dramatically. Whether the ECB moves immediately or waits another month remains to be seen. The ingrained conservatism of Europe’s central bank suggests it may well sit on its hands for another month or perhaps two. But some form of QE is now a done deal. Once prices are falling across the continent, and now that the legal argument has been dismissed, what possible reason can there be for holding back? The arguments about how deflation can crucify highly indebted nations — such as all the peripheral euro-zone countries — are too familiar to need to be rehashed. The single currency won’t survive a sustained period of falling prices and everyone knows it. The ECB’s mandate is stability — not a collapse in prices. How much QE will the ECB unleash? Germany’s DIW economics institute came up with the number of $60 billion a month. That is probably on the low side. At its peak, the Federal Reserve was pumping $85 billion into the American economy. Given that the euro-zone economy is about the same size, it will take at least as much QE to have any impact. You could argue for more — the euro-zone is in worse shape than the U.S. ever was. Whatever the final decision, it will have to be a lot to have any chance of working. The one thing we know for sure about QE is that it boosts asset prices — and not just in the region where the money is being printed. It spills into markets around the world. This bull market has been driven by central banks printing money, mainly in the U.S. but also in Japan and the U.K. The Fed is gradually winding down its program, and the U.K. is unlikely to roll out the presses again given the strength of its recovery this year. But the ECB has so far stayed out of the game. If it starts its own QE blitz, that will inevitably give the markets a fresh boost. It will help stock markets in Europe, of course, since that is one of the main ways printing money boosts the economy. But it will flood into the emerging markets, the U.K. and U.S. just as much, in the same way the Fed’s program boosted other markets around the world. It might even boost world markets more than Europe’s. Investors will take the ECB’s money and put it into economies with stronger growth prospects than Germany, France or Italy. The bull market will come to an end at some point — they all do. But the ECB is about to extend its life by another 12 to 18 months. |
