Europe can be divided into two eras, the one before Mario Draghi became president of the European Central Bank, in late 2011, and the one after.
The pre-Draghi era was a nightmare. The financial and debt crises had crippled some of Europe's biggest banks, triggered deep recessions and three sovereign bailouts, sent unemployment well into double digits and nearly saw the exodus of Greece from the euro zone.
The Draghi era has been, relatively speaking, a picnic. Thanks to the ECB's firefighting efforts, including quantitative easing (QE), the euro remained intact, government-funding costs plummeted and growth and inflation made tentative comebacks. The crisis is no more, but the good news is also the bad news because Mr. Draghi's seemingly endless and lavish fix-it programs have allowed governments to relax. Why bother launching ambitious economic reform programs when rich, kindly Uncle Mario keeps flashing his credit card?
Several European countries are in full-throttle election mode, and notice how none of the would-be presidents and prime ministers talks about how the economy will change when the ECB withdraws its support. The ECB is already doing to. The €80-billion ($112-billion)-a-month QE program is to be trimmed to €60-billion a month, starting in April.
While Mr. Draghi insists QE is essentially open-ended, there is no denying that it is finally working its magic. Annual growth in the euro zone is running at a not-too-shabby 1.7 per cent while core inflation is rising remarkably fast, recently hitting 0.9 per cent. True, inflation is still well below the ECB's target rate of close to 2 per cent. But there is no doubt the threat of deflation (falling prices) is gone. Inflation is back – mission accomplished, as far as leading QE-skeptic Germany is concerned.
The point being, it's unimaginable that the monthly asset purchases under QE will be boosted at this stage and it's entirely imaginable that QE will be slowly phased out over the next year or two. Then what? How will the euro-zone governments adapt to the end of the freebie era?
QE has been a godsend to treasuries and finance ministers. The enormous money-printing exercise has helped to push down sovereign bond yields to tiny levels, allowing politicians to argue that austerity measures can be diluted. Why not borrow billions to restore various programs (i.e., buy votes) when even struggling economies can borrow at next to nothing. The yield on Italian 10-year bonds was 7 per cent during the peak of the crisis, a level that triggered the bailouts of Greece, Ireland and Portugal. Today, Italy can borrow at 2.2 per cent – cheaper than the United States can borrow – and the spread over iron-clad German bonds is only 1.8 percentage points (the German yield is less than 0.5 per cent). Spain, where unemployment is 18 per cent, can borrow 10-year money at 1.6 per cent.
Now you know why debt-to-gross domestic product ratios are still climbing in the euro-zone countries. Apparently, finance ministers believe that it's okay to slather more debt onto debt as long as interest rates remain low.
At some point, the end of QE will rudely interrupt the finance ministers' parties. On its own, QE is pretty good at preventing economic catastrophes. What it cannot do is make economies more productive and efficient. Only tough structural reforms, combined with clever infrastructure spending, can do that.
But forget it. European politicians have talked a good game but have rarely introduced measures that made their economies more competitive. France and Italy are gearing up for elections but the talk is as much, or more, about immigration, refugees, terrorism, national identities and the European Union's post-Brexit existential spasms than it is about preparing economies for the end of QE.
You can already see where this is going. QE winds down and euro-zone bond spreads over German bonds widen. When investors realize that euro-zone economies (absent Germany) are not much more competitive than they before the QE, spreads widen again. Then there is the Donald Trump factor, the wildest of wild cards. If his "America first" protectionist measures hit Europe and its exports, the debt crisis that we all forgot about after Mr. Draghi swung into action could come roaring back.
Mr. Draghi obviously knows that his QE program has its downsides. That's why he ends every one of his monthly ECB rate-setting conferences with a plea for governments to bolster their reform efforts. Some investors seem to have figured out already that problems lie ahead in the weaker euro-zone countries and that QE is masking a lot of sins. Maybe that's why they're happy to buy German bonds in spite of their negligible yields.