No shock, little awe

Originally published in the Jerusalem Post on January 23, 2015. 

On Thursday, after months of build-up and weeks of intense speculation, European Central Bank (ECB) President Mario Draghi finally unveiled his program of bond-buying, otherwise known as QE. The details are important but require too much space — so let’s cut straight to the bottom line, which is that the ECB intends to purchase 60 billion euros worth of bonds every month, through September 2016.

A program amounting to 1.2 trillion euros is a lot of money. But the market response, whilst positive, was relatively restrained. In the context of the metaphor of Draghi finally firing the bazooka that he loaded back in August 2012 – when he promised to do ‘whatever it takes’ to end the euro crisis – the markets were certainly not blown away.

But then how could they be, when they had been preparing themselves for weeks, if not months, for precisely this eventuality. Indeed, much of the speculation in the run-up to the announcement was over the extent to which prices already reflected the expected announcement – and whether whatever Draghi actually said would be seen as a disappointment compared to the expectations.

The initial response, of European stocks climbing still higher than they already were, the euro and other European currencies falling even lower (against the dollar) than they already were, and the yields on sovereign bonds of the core euro countries plumbing still lower depths, was definitely not one of disappointment.

But the reason the markets were restrained yesterday, whereas last Thursday they ran berserk in all directions, is undoubtedly because this time almost everything except the exact details and amounts had been discussed and even leaked in advance. The contrast with the Swiss National Bank’s announcement last Thursday that it was removing the cap on the franc/euro exchange rate, which came totally out of the blue, could hardly have been greater.

In short, yesterday was a day of no shock – hence the muted response to Draghi’s words. But the success or failure of the ECB move will not be decided by the market response in the hours and days following its announcement. It will be seen in terms of its declared or perceived aims and whether they will be realized.

These aims are to provide yet more liquidity to the euro economy, via the financial markets and the banking system, so as to boost economic activity – at the least, to prevent or arrest the slide of the eurozone economy into recession. By the same token, although Draghi did not use the dreaded D word even once in his press conference yesterday, the perceived aim of this hyper-expansive monetary policy is to prevent – or arrest – the slide of the eurozone into deflation.

It therefore follows that if economic activity expands and inflation moves back to positive levels, ideally towards the “slightly less than 2% per annum” benchmark that the ECB uses, then Draghi’s massive QE will be seen as having handsomely succeeded. If, on the other hand, growth and inflation continue to hover around zero-to-slightly-negative levels, let alone if they sink further below zero, then it will be proclaimed a failure.

Those are the parameters, but the biggest problem facing this, the ECB’s very belated plunge into the kind of monetary policy it formerly eschewed (and that the Germans and their allies still oppose), is that QE is no longer shocking and unorthodox. It has become the new orthodoxy of central banks around the world, from Washington to London to Tokyo, but what is much worse is that it is increasingly seen – even by the economic school that supports it in theory – as ineffective.

This explains the total lack of awe generated by Draghi. Only a few years ago, a stimulus plan of one trillion dollars, euros or pounds (or one hundred trillion yen) was unimaginable. Now, after the world has collectively spent or committed to spend over ten trillion dollars on these programs (including Draghi’s), the awe is out and the jury is back in. The verdict is that the impact of each succeeding dose of monetary stimulus is less than its predecessor, so that more is less.

There is a fierce argument as to whether the perceived benefits of QE are worth the costs – in other words, whether the short-term spur to feeble economies is justified, given the extra debt that is created and that must, at some point, be repaid. The unspoken rationale in favor of QE was that it would generate enough inflation to rapidly erode the value of the entire debt burden of the governments that undertook it.

The anti-QE camp said from the outset that the cost exceeded the benefits, but it was a small minority to start with. However, after more than six years of QE experience, the anti camp has swollen considerably, not because of theoretical considerations but because reality has demonstrated that, as noted, each dose has less impact.

In fact, despite the trillions pumped into the global financial system, the developed world is now sinking into deflation, while growth – as the IMF confirmed again this week when it cut its forecast for 2015 – is low-to-non-existent.

Last Thursday, the SNB threw in the towel. This Thursday, the ECB picked up the gauntlet. The metaphors may be mixed, but the outcome will be clear-cut – and not long in coming.

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