On September 12, the European Central Bank decided to launch yet another asset-purchase program, with plans to buy €20 billion ($22 billion) in new securities per month for an indefinite period of time, using the same structure as it has in the past. The decision was not made unanimously: the German, French, Dutch, Austrian, and Estonian members of the ECB council have all voiced fierce opposition to further quantitative easing (QE).
ECB President Mario Draghi claims that the majority in favor of further loosening was so large that it was unnecessary even to count the votes. Never mind that the countries opposing the decision hold 56% of the ECB’s paid-in equity capital and account for 60% of eurozone output. Counting their compatriots on the ECB Governing Council, however, they have only seven out of 25 potential votes (subject to a rotating limitation). Draghi did have a majority, then, but it represented a very clear minority of the ECB’s liable capital. This raises considerable concerns about the Governing Council’s decision-making process.
Such concerns are all the more justified considering that US President Donald Trump has been complaining loudly about the implied exchange-rate policy stemming from ECB asset purchases. He has a point. Draghi, of course, insists that the ECB does not “target” the exchange rate. While that may be true, it is beside the point. By purchasing long-term securities, eurozone central banks will once again trigger a currency devaluation. Indeed, it is precisely this effect that likely plays the dominant role in stimulating economic activity.
The problem, of course, is that by stimulating exports and curbing imports, the policy comes at the expense of other countries. Worse, other stimulus effects of interest-rate reductions are rather limited, particularly with respect to investment. There is even reason to fear – as Deutsche Bank CEO Christian Sewing does – that the ECB’s ongoing rate reductions had a detrimental effect on the banking system, thereby putting the credit supply at risk.
The economic mechanism by which the ECB achieves devaluation was explained decades ago by the so-called asset approach. If European central banks purchase European securities with freshly printed money, they distort the international portfolio equilibrium with regard to domestic and foreign currencies and interest-bearing assets, and a currency devaluation is needed to rebalance it. Some of the sellers will offer euros on the currency markets, in order to purchase non-European securities. And that will put downward pressure on the euro exchange rate. Foreign sellers will trade in their own assets for European securities only when the euro exchange rate is lower. The new international portfolio equilibrium ushered in by the ECB is accompanied by euro depreciation.
During the ECB’s first round of QE, the portfolio shifts were clearly noticeable among sellers of government bonds, as the ECB itself has documented. Those sellers mainly used the proceeds to purchase US Treasury bonds, because they wanted to stay within the same asset class. US sellers, on the other hand, used the euros they received to purchase European corporate assets, which had become cheaper, owing to the fall in the euro exchange rate.
In the context of the ECB’s first large asset-purchase program, the euro’s exchange rate fell by around a quarter against the dollar between mid-2014 and January 2015, when the program was formally launched, because traders generally assumed that the program would happen and acted accordingly. Italian banks, in particular, got a head start in buying up European securities worldwide, by tapping (disproportionately) into funds from the targeted longer-term financing operations (TLTRO) program that the ECB had launched in June 2014.
The ECB vehemently denies that it pursues an exchange-rate policy, because it knows that doing so falls well outside its mandate. But there is simply no denying that its policy comes at the expense of Europe’s trading partners. The situation is eerily reminiscent of the competitive devaluations of the 1930s.
When the US Federal Reserve, following in the footsteps of the Bank of Japan, pursued a similar policy some years ago, then-Fed Chair Ben Bernanke openly acknowledged the exchange-rate effects of QE, although he said that it was not quite clear how they came about. When the Europeans later followed suit with their own QE program, they were, in a manner of speaking, taking their allotted swig from the bottle.
The Trump administration knows all of this, as does everybody else. But Trump has warned Europe repeatedly not to get greedy. To avoid becoming the “beggared” neighbor, he continues to hold out the threat of trade sanctions.
Europe therefore has a choice. It can continue to allow the ECB Governing Council to pursue its own (implicit) exchange-rate policy, or it can decide that the looming trade conflict with America belongs in the hands of democratically controlled institutions. The central banks are out of their league on this one.
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