Time for Europe to print money

In June, Ben Bernanke, Chairman of the US Federal Reserve, announced that he was considering “tapering” the Fed’s programme of quantitative easing. By this he meant that, as the US economy was showing signs of improvement, the central bank was no longer going to pump money into the domestic—and by extension the global—economy. World markets panicked.

We can learn two things from this. First, the US is still the main market to watch, especially now there are signs of a slowdown in China and other large emerging economies. When Bernanke sneezes, the rest of the world catches a serious cold. Second, the violent reaction to a simple hint that at some point the $85bn monthly injections of money by the Fed may have to slow down and possibly even stop points to a serious underlying weakness in the world economy. Forecasts for growth for 2013 had already been downgraded by the World Bank, the International Monetary Fund and others. It has now become clearer, if that extra evidence were needed, that the exuberance in global markets was sustained not by economic reality but by the US emitting trillions of dollars.

A retrenchment and, even more worryingly, a reversal of the policy would threaten to stop all this. The Fed seems to have been rather taken aback by the extent of the reaction to its announcement and has been at pains ever since to re-emphasise its intention to keep the zero interest rate policy for as long as possible, certainly while unemployment in the US remains stubbornly high. But that isn’t reassurance enough. Some projections suggest that unemployment will reach more favourable levels in 2014. Indeed the markets saw the latest better-than-expected US payroll data as a sign that the improvement in the US economy was gathering pace. There is therefore a possibility that the reduction in quantitative easing will start in the autumn and reach its conclusion sometime next year.

The repercussions of this for the eurozone will be significant. The European Central Bank has already reduced its interest rate to a record low of 0.5 per cent and is encouraging the banks to lend to companies. It may have to cut rates again.

As fiscal austerity remains the name of the game, monetary policy is the only instrument available to stimulate the eurozone economy. There, unemployment continues to rise. The youth unemployment rate is almost 25 per cent on average—with more than double that rate in Greece, nearly double in Spain and at over 40 per cent in Italy. There is concern of a serious credit crunch already developing in a number of debt-ridden “peripheral” countries.

In Greece, it looks as if the much expected improvement in deficit reduction in 2012-13 has gone into reverse. The economy has declined for its sixth successive year and people either cannot or will not pay their taxes. The reduction planned in the number of public sector workers will make little difference to the overall numbers in the short term and the debt will carry on growing.

If the Fed were to withdraw from quantitative easing, then the consequences for Greece would be fierce. The assets held by Greek banks and other institutions would drop sharply in value—this could bring about a new crisis. This goes not only for Greece, but also for Cyprus, Spain and more widely. The answer must be for the ECB to start in earnest and as soon as possible the “Outright Monetary Transactions” scheme that its President, Mario Draghi, announced last autumn—a scheme that would be similar in its effects to the Fed’s quantitative easing. It may need to be deployed soon, as Draghi has hinted, even though frustratingly the scheme’s legality is being challenged by the German constitutional court.

We may have to wait until after Germany’s September elections for a resolution and action. But the eurozone will have to grapple with the fact that on current economic trends, debt levels in many countries will remain unsustainable and more write-offs will be inevitable. At the same time, Europe’s central bank will have to step in and start pumping in some money if it wants to avoid a fall in confidence as the US reduces its own monetary infusions. It is time for Draghi to show that he can keep his declared promise to do whatever it takes to save the eurozone.