The latest Eurostat data on employment and industrial production for the Eurozone economy point invariably to stagnation, if not recession, while the long-term tendency of household consumption, as a percentage of GDP, appears falling. In short all the key growth indicators of the economy are quite disappointing, to say the least. The economic problems of Europe are also aggravated, by the growing over-indebtedness of a large number of euro area governments.
Add to all that the malignant swelling of the exposure of major European banks to risky placements, together with their menacing undercapitalisation and the single euro area prospects appear depressing. During the last weeks however a new negative element appeared; the fast falling prices of crude oil and energy. Under different circumstances this latest development would have been a blessing, but the way it happens now can have negative effects. Let’s start the story from the beginning.
The miserable conjuncture
This gloomy scenery has led the European Central Bank to seriously contemplate the application of a much more comprehensive quantitative easing policy, aimed at flooding the financial markets with more freshly printed euros. Up to now ECB’s Governing Council, including its two German members, has unanimously undersigned Mario Draghi’s open market policy proposals (more liquidity to the economy), amounting to euro one trillion. Yet, Germany blocks the application of these monetary measures.
During the last few weeks the ECB has distributed some euro billions under two new programmes. By 5 December the Asset Backed Securities Purchase Programme (ABS PP) amounted to a mere €600 million and the Covered Bond Purchase Programme (CBPP3) to €21bn. This is nothing though compared with the target ECB set in October to flood the euro area financial markets with a trillion.
The ‘wonders’ of 2010 and 2012
It’s also nothing compared to the Securities Markets Programme (SMP), initiated on 10 May 2010 and terminated in September 2012, after having reached €144bn. That was something. But for whom? According to ECB, the SMP was introduced “with a view to addressing the severe tensions in certain market segments which had been hampering the monetary policy transmission mechanism”. The real reason behind the SMP was to save some almost bankrupt giant EU banks, who had lent imprudently hundreds of billion to failing Greece. ECB didn’t restrict its SMP purchases only to Greek debt. It also acquired Italian, Irish, Portuguese and Spanish paper.
At that time Berlin didn’t just support ECB’s decision. It pressed hard for it. You see, it was the ‘health’ of the German banks that was at stake, and Wolfgang Schäuble didn’t mind much, if this policy was probably outside ECB’s mandate. To be reminded that the central bank then bought sovereign bonds at the secondary market. In this way it supported the price of the relevant paper and also helped Italy and Spain to borough cheaply in their primary debt market.
The German double standards
The German government had also no serious objection in the summer of 2012, when the ECB intervened to save once more the euro area. It was on 6 September 2012 when ECB initiated the famous for their unquestionable success Outright Monetary Transactions. It was the time when Mario Draghi said the era changing phrase, “the ECB will do whatever it takes to save the euro, and believe me it will be enough”. Under the OMTs the ECB announced that it was ready to buy unlimited quantities of sovereign bonds, in order to save the euro area from melting down.
Everyone remembers those dreadful times. Banks and governments run the danger to go bankrupt together, at the helm of the second Greek crisis. The Greek virus has infected the entire south Eurozone and not only. However, it was again primarily the major European banks, with the German ones at their forefront, which had to be rescued first. The impressive result was that the sovereign debt markets evened out and actually the yields fell, without the ECB having to spend not one euro. Just the decisiveness of the statement was enough to stabilize the markets at much lower levels interest rate wise.
Currently, ECB and Draghi are again contemplating to intervene in the sovereign debt market, but this time not to save the Eurozone from falling apart. The odds are not that precarious; at least not yet. The problem is that Eurozone is caught in a disinflation (falling or too low inflation) and stagnation trap, which may evolve into a new recession. In such an environment, the abrupt fall of the energy prices may drag all prices deep into the negative area. Then things may become really precarious. Energy is incorporated in every product or service.
The Wall Street Journal reported yesterday, that the head of the Organization of Petroleum Exporting Countries, Abdalla Salem el-Badri as saying that OPEC has not set a price target for crude oil. Other sources say that OPEC is willing to allow crude oil prices to fall even to $40 a barrel. This means crude oil, the most precious commodity, is losing the largest part of its value within weeks.
Understandably, under different circumstances this development would have been a benediction for the oil consuming Eurozone. Unfortunately, such a sudden drop of the price of energy may introduce a chain reaction of the price structure and demolish the entire edifice. It may drag Eurozone in the abyss of deflation (negative inflation, constantly falling prices). In such an eventuality, the euro area, with unemployment already stuck in the double digits region and growth rates close to zero, would fall victim of its inability to seize the opportunities in the changing horizons of the energy universe.
Inflation may dive into the negative part of the chart, without an apparent presence of adequate backstops, like a possible effective increase of consumption and investment spending, as in the US. Despite all that, Germany still champions austerity and blocks the ECB from buying sovereign bonds at significant quantities, so as the Eurozone member state governments could support investment and consumption in their territory. Only in this way the euro area can avoid a new and much more dangerous recession.
The trouble is that now things evolve very fast. If the much-needed ECB’s intervention to help member states with their liquidity problems is further delayed, the crisis will certainly catch up. Then even additional trillions, than the one planned to be printed, may prove not enough to save Eurozone from a new calamity. For Eurozone to avoid that, Germany should allow Draghi to print and distribute at least the one trillion, as ECB has already decide, and be it rather fast, within the first months of 2015. Otherwise the economic and political repercussion would be catastrophic.