The financial economy and markets of euro-zone countries had been walking around in a daze and then, this past week, it was slapped back into reality by European Central Bank (ECB) President Mario Draghi.
The Italian announced that in addition to a widely anticipated program of bond buying, the ECB would lower interest rates.
What made this such a stunner was that in July, the ECB had already pushed a key interest rate on excess reserves to negative 0.10%, meaning that banks holding more than their required reserves at the ECB would be charged 0.10% for the privilege.
The goal was to motivate banks to withdraw the excess money and lend it to businesses and consumers, thereby sparking economic activity.
Just as we forecast, it didn’t work.
It was unprecedented when the ECB pushed the interest on excess reserves below zero, so it was even more surprising when they skewed it even further below zero…
It was as if the ECB President was telling the world: “We don’t know what to do next, so we’re going to try more of what hasn’t worked.”
We almost agree. It’s not that the very smart people at the ECB and the central banks of euro-zone countries don’t know what to do; they just don’t want to do it.
At this point, there’s no way to avoid the elephant in the room. European countries are hobbled by excess debt that was piled on during the booming 2000s, and then made worse by government borrowing in the years that followed.
Since the financial crisis, we have pointed out that European countries won’t experience meaningful recoveries until they deal with their excess debt, both public and private.
Even when Draghi made his famous statement in 2012 that the ECB would do “whatever it takes” to preserve the euro, we noted that short of printing new euros to buy up bad debt, there wasn’t much the central bank could do. We consistently argued that the ECB would eventually move to cheapen the euro in response to poor economic data, but we were far outnumbered by euro-optimists who saw nothing but good times ahead.
In the months and years that followed, the euro soared, reaching almost $1.40, as the world took Draghi’s comments to mean that the ECB would basically save every country in the bloc… no matter how screwed up they were. We remained skeptics of the euro-zone recovery, and of the euro itself, even as the currency moved higher.
While European stock markets soared along with the euro, the economic releases kept reiterating our point. Growth wasn’t returning to the region as a whole, and the inflation target of 2% remained elusive.
In fact, several countries were falling back into recession, and the economic bloc was moving closer to outright deflation. The euro-optimists kept hoping, and investing, for the best, but now the problems have simply become too big to ignore, and sentiment has turned.
In addition to forcing dollars out of the central bank, the ECB is desperately trying to torpedo the euro in hopes that a cheaper exchange rate will boost European exports so that their economies can grow their way out of their debt morass. The question is: “Export to where?”
Will China, the land of a bursting property bubble, buy enough from Europe to save the economic bloc? Will Russia, the seeming invaders of Ukraine, suddenly have a desire for more Western goods? Will the U.S., with its own mediocre job growth and stumbling economy, want more things from across the pond?
None of it seems very likely, particularly when every other major country is hoping to pursue the exact same strategy.
It might have taken years for many people to wake up to the reality of the situation in the euro zone, but at least it has finally come to pass. Maybe now the central bank leaders from the member countries, as well as the ECB, can develop a plan for identifying and clearing out the overhang of debt that’s weighing so heavily on their economies.
It won’t be easy to do. Losses will be incurred, and unfortunately it’s most likely the responsible taxpayers across the region that will take the hit. But until this problem is tackled, the euro zone will remain stuck in neutral at best, and could even slide into reverse.
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