Are ECB’s €500 billion enough to revive Eurozone? Will the banks pass it to the real economy?

Frans Timmermans, First Vice-President of the EC in charge of Better Regulation, the Rule of Law and the Charter of Fundamental Rights, Valdis Dombrovskis, Vice-President of the EC in charge of the Euro and Social Dialogue, and Corina Creţu, Member of the EC in charge of Regional Policy, went to Riga where they participated in a debate about the future of Europe at the “Riga Latvian Society House”. The event was hosted by the first Latvian Presidency of the Council of the EU. (EC Audiovisual Services, 08/01/2015).

The major indicators that an economy is in recession and probably heading to something worse like a crisis, are falling prices and crumbling wages. Eurozone suffers of both of them. According to Eurostat, the EU statistical service, the annual growth of labour cost dropped in the euro area to 1.3% during the third quarter of last year, compared with 1.4% in the April-June period. As for the consumer price developments, the same source published last week its flash estimate for December inflation, finding it below the zero line at -0.2%. It just descended to the negative area for the first time after the summer of 2009, right at the heart of the then free raging financial crisis. Let’s take one thing at a time.

Labour cost, despite the fact that it contains charges not related to the workers’ take home pay it’s a very reliable indicator of it. Take home pay is what it counts when discussing the growth potential of an economy. Obviously consumption expenditure, the largest part of GDP and the strongest driver of growth, is tightly related to workers’ take home pay. In the case of Eurozone the overall level of wages and consequently the level of take home pay stagnate for quite some time now. By the same token, nominal hourly labour cost in the business sector of Eurozone’s economy also oscillates around a percentage unit for four quarters in a row, from the third quarter of 2013 up to the same period of 2014. It becomes evident that all along this period the positive changes of these crucial variables measuring take home pay are quite negligible. That’s why economic growth in Europe is also insignificant.

Stagnant wages and negative inflation

Price developments (aka inflation), the other indicator of growth, are also frustrating. After last June the yearly rate of change of the relevant index in Eurozone remained below the 0.5% benchmark and on a monthly base it became negative (-0.2%) in November. Even worse, as mentioned above, the next month Eurostat found that the December inflation was negative also on the yearly base.

Inflation and wages are not the only crucial economic variables which indicate that economic recession has taken grip of the euro area. Industrial production is equally disappointing. In most euro area countries industrial production keeps falling for many years. Germany was an exception. Unfortunately not any more. According to the Federal Statistical Office of Germany, factory orders dropped by 2.4% in November in comparison with the previous month. The fall was judged to be lower than the analysts expected.

Can the devalued euro help Eurozone?

In view of all that last Friday, the euro fell below 1.176 against the American dollar. Under different circumstances this could have set the Eurozone economy in motion. Regrettably, it seems though that the fall of the international value of the euro is not enough to act as a growth catalyst for Eurozone. The rest of the world is not in a much better shape and cannot increase noticeably its demand for European products. So growth in euro area has to be internally propelled. As a result, the single European currency is expected to fall further. There are wild predictions about parity with the US dollar within this year.

ECB to print more euros

Of course the descent of the euro is related not only to the bleak economic prospects of Eurozone, but also to the expectation of more quantitative easing by the European Central Bank. Last Thursday the European Sting writer Suzan A. Kane reported that “This week more indications emerged pointing to the possibility that the European Central Bank is to announce a government bond purchases programme sooner than expected”.

Reportedly, this means the ECB can very soon print up to €500 billion and throw it in to Europe’s financial markets. The more paper money spins around the less it’s real value is. Undoubtedly then the euro will continue to devalue in relation to the dollar and the British pound. The question is if this extra money is enough to revive Eurozone’s real economy. The US central bank, the Fed, had to print $4 trillion in order to help the American economy start growing again. Many analysts think that half a trillion euro is too little too late to restart the European economy. Predictably, it will be directed to the secondary markets of state debt, where the giant banks – mainly German and French – are lurking. The banks will quite happily unload their investments on government bonds for the much cherished cash freshly printed by the ECB and handed to them.

Again the banks to get it first

Theoretically, this ECB’s new policy measure will help the Eurozone governments and the business sector to borrow cheaply in order to finance new investments. However, as in the recent past, the question remains, up to what point are the giant European banks going to use this extra liquidity to lend more money to the real economy? A large part of it will be used to finance the banks’ own ‘investments’ in risky markets, like the derivatives or developing world financing, where the lenders expect to make quick and large profits.

In short, the dimensions of the positive impact this new ECB’s half trillion handed to banks is to have on the real economy again depends on the good will of the banks. Can the ECB force them to act according to the interests of the entire society and not use the new money for their own ‘investments’? Unfortunately the answer is rather not.