We are approaching the time when the ECB will pull the trigger and will start buying paper “assets” (i.e. someone else’s liabilities) in the ultimate hope of stimulating a paralytic EU economy that is devastated by regulations, high taxes, unsustainable debt and unfunded liabilities. The zero-bound interest rate trap is about one thing: depressing the expected rates of returns to real investments and thus setting up the economy for an era of diminished expectations. This is the epoch where the self-inflicted wounds are coming not from what we hate (putting our economic and financial houses in order), but rather from what we love (easy money).
The expected “asset” purchases by the ECB cannot heal the EU’s problems for several reasons. Here are a few basic ones:
Those “asset” purchases will not increase the EU’s money supply. They will increase the banks’ reserves, but will have no effect on the amount of funds circulating in the economy.
As a result of the above the velocity of money will continue dropping in the EU which in turn will depress demand for credit.
EU banks have so many non-performing assets that any reserves will be hoarded rather than being used for loans. As I wrote recently their Texas ratio (non-performing assets divided by equity plus precautionary reserves for write offs) is so high that it makes most of them pretty shaky.
The collateral holes are so big that it will take years and a miracle to return those banks to healthy status. As a result, the velocity of collateral has been declining and without a reversal in that downward trend there is very limited hope of reversing the declining velocity of money. Consequently, the deflationary pressures are exacerbated.
The desire of businesses and households to deleverage will not be reversed due to the “asset” purchases by the ECB, because the expectations for profitability are depressed. As a result, aggregate demand will not be affected, which in turn will not allow capital investments to occur despite the lower rates and the possibility of funding.
The very unfortunate thing is that by its decision the ECB trivializes the reality of an EU-wide crisis that has been caused by flawed judgment, inadequate leadership, bad decisions, ahistorical policies, incompetent practices, and vested interests. As the ECB embarks on its voyage and as Japan sits in the middle of its ocean of QEs, Asian currencies will feel the developed economies appetite for cheapening their currencies and as they may be embarking on their own voyage, China with its own bubbles and non- performing loans may be tempted to devalue at a time when the US will be raising rates. That would be the time to wonder – as Neil Postman did in his book “Amusing Ourselves to Death” – if Huxley (and his “Brave New World”) was right rather than Orwell (in his 1984 book). Let’s recall that contrast.
Fearful of those who may ban books
No need for such a fear, since nobody will read serious books
Fearful of those who deprive us of information
No need for such a fear since we will be buried with information overload that reduces us to passivity
Fearful of those who will conceal the truth from us
No need for such a fear since truth will become irrelevant
Fearful of an oppressor who will deprive us of our autonomy
No need for such a fear since people will love their oppressors
Fearful that we will become a captive culture
Over-rated fear since we are becoming a trivial culture
Fearful of those who will control us by inflicting pain
Fearful of those who will control us by inflicting pleasure
The times they are a changing and rather than lighting up candles that shine light and make things clear, we extinguish the elements (such as the cathartic possibility of failures) that can truly liberate us from our fears and boneheaded policies and mentalities.
The AEC’s fundamental goal is to promote a free, responsible and prosperous society. Through education and improving public understanding of key economic questions, the AEC promotes the idea of a free market economy and the ideal of a free society.