In Europe, failure is no longer an option. If banks are in danger of collapse, in come the bailout loans. If countries have trouble financing themselves, the European Central Bank will buy their sovereign bonds. When inflation falls and growth stalls, there is a cure for that too – quantitative easing.
QE, as it's called, was officially announced in January and launched on March 9 by the ECB. The €2.1-trillion ($2.8-trillion) exercise in printing money began to work its magic well before the first sovereign bonds were bought because every sentient life form on the continent knew it was coming, and coming big, as inflation turned negative. Bond yields plummeted and the stock markets climbed, boosting the wealth effect and consumer confidence. The euro sank like a lead balloon, a godsend to exporters.
With QE in place, and oil prices in the tank, any thought of a new European recession is gone. Economists are busy rewriting growth forecasts and expect a 1.5-per-cent uptick in euro zone gross domestic product this year and 1.9 per cent next year. Greece is the one potential pitfall. If it stumbles out of the euro zone, contagion could wreck the party. But Europe won't tolerate a sovereign failure any more than a banking failure. To keep Greece in the euro zone, it will almost certainly get another bailout equipped with bargain debt-repayment terms.
ECB President Mario Draghi and the euro zone finance ministers are beaming like Cheshire cats as the economy lurches back to life – all hail QE! Not so fast, for what QE gives, it can also take away.
QE is voodoo economics; no two economists will agree why it works or whether it works at all (its performance in Japan, QE's inventor, has been cheerless). In Europe, it does seem to be working, but already its negative aspects are taking root. QE could well prove to be temporary balm rather than long-term cure.
The bond yields of certain countries provide the first clue that QE's benefits are overhyped. Take Italy, the euro zone's third-largest economy. On Friday, its 10-year bonds were trading with a yield of 1.3 per cent. That's a drop of two full percentage points over a year, allowing it to borrow money more cheaply than Canada, the United States or Britain, to name but three far healthier economies. At the height of the debt crisis in 2010 and 2011, Italian yields were close to 7 per cent, a level that had the European Union and the International Monetary Fund wondering if there were enough money on the planet to bail out a Group of Seven country. Spain, saddled with the highest jobless rate in the Western world, can borrow even more cheaply than Italy. And Portugal, which was bailed out in 2010, doesn't have to pay much more than Italy for its debt.
Guess what happens when uncompetitive countries get money for nothing? Their governments declare victory and retreat. In Europe's low- to nil-growth Mediterranean flank, where the sun shines on the backs of a lost generation of unemployed youth, economic reform has moved forward with all the alacrity of a lobotomized sloth. It's like owning a house with a big, fat, expensive mortgage on it. You work like hell to pay it off. But when the rates drop to almost nothing, the pressure is off and you book a holiday to Disney World.
If their bond yields were close to crisis levels, you can bet the urge to reform would have been intense. In that sense, Mr. Draghi's cheap money ploy isn't so cheap. It may be setting up the next crisis as uncompetitive economies remain uncompetitive.
Rock-bottom yields come with another problem – they penalize savers and reward borrowers. They are especially hard on pensioners, whose numbers are surging as the population ages, and pension and insurance funds, which typically match long-term liabilities with long-term assets such as 10-year bonds. The good news is that the low bond yields, thanks to QE, will encourage investors to find higher returns elsewhere in the economy, potentially boosting growth. But if the risk-taking gets too risky, bubbles can form and proof that a bubble exists only comes when it bursts.
Still another problem with QE is its rather efficient ability to make the rich richer. When QE does what it is supposed to do, it boosts asset prices, from equities to houses, propelling the wealth effect. The trouble is that most of the assets that get juiced up are owned by the wealthy, who tend not to spend the extra money they earn since they need only so many luxury homes, cars and yachts. If QE were to help the poor as much as the rich, you might see unemployment drop faster. In the euro zone, it seems stuck at about 10 per cent.
Almost everyone in Europe was clamouring for QE – central bankers, finance ministers, investors, the wealthy, manufacturers, exporters, employers. It may paper over the cracks for a while. What it won't do is fill them. Post-QE Europe will probably be just as uncompetitive as pre-QE Europe, maybe more so.
Eric Reguly