Why Eurozone urgently needs the ECB to print and distribute at least €500 billion

Jyrki Katainen, Vice-President of the EC in charge of Jobs and Growth went to Rome where he attended a meeting of the Italian Chamber of Deputies. The Vice-President then attended two meetings with Pietro Carlo Padoan, Italian Minister for Economy and Finances, and Federica Guidi, Italian Minister for Economic Development. This journey to Italy will be followed by several visits in 2015 as part of the “Investment Roadshow”, aimed at promoting the EU strategic investment plan presented by the Juncker Commission at the European Parliament on 26/11/2014. National projects under this Juncker plan, can be financed by newly printed euros. A view of the lunch – talk at ISPI. (EC Audiovisual Services 16/01/2015).

Next Thursday 22 January the European Central Bank is expected to announce its new extraordinary monetary program (quantitative easing), under which the central bank or the 19 member state national central banks will buy up to 20%-25% of Eurozone’s government debt. According to Eurostat, the government consolidated gross debt is around €9 trillion. Theoretically then the ECB could purchase state bonds of up to €2.25tn, but sources say that the total amount of state debt to be purchased   won’t surpass €500 billion, at least at the initial phase of the program. All that of course to fight the dangerously negative inflation in Eurozone.

Reportedly, the two German members of ECB’s Governing Council, Jens Weidmann, President of the Deutsche Bundesbank and Sabine Lautenschläger, a Member of the Executive Board oppose the program and will vote negatively. However, according to other sources even Klaas Knot, President of De Nederlandsche Bank will not follow his German colleagues, despite the fact that The Hague is considered a close ally to Berlin when it comes to Eurozone’s financial affairs. Knot said that the purchases of sovereign debt should be conducted by the 19 national central banks, so as the individual country risks do not spread all over the euro area and are not mutualised.

Switzerland drops the euro

There are few doubts around the prospect that the majority of ECB’s Governing Council members are indeed ready to launch this new ground breaking monetary program. Apart from the relevant information given by ECB officials, the abrupt, and catastrophic for many, decommitment of the Swiss National Bank from its three-year old pledge to keep the euro – frank parity at 1.2, is a strong indication towards this direction. The Swiss National Bank couldn’t afford to continue buying billions of euros at the rate of 1.2 by means of printing francs. That’s why they decided to abandon this pledge. Last Friday the franc/euro market ratio fell near parity at 1.02.

On top of that, the deep dive of the single European currency against the dollar below the 1.15 benchmark for the first time since 2003, is another infallible witness that the Eurozone central bank is ready to flood Eurozone with freshly printed money. The more of it is spinning around the less its value. In reality the global financial system has already discounted that Mario Draghi, the President of ECB is to announce next Thursday this groundbreaking sovereign bond purchases program. If he doesn’t, world markets will be extremely distressed.

Will it be enough?

There is one more question though. Will the €500bn be enough to wake up the Eurozone economy and revive the falling prices? In all likelihood, the program will be used to buy sovereign bonds in the secondary markets, that is paper issued in the past and being presently held by the financial institutions, aka banks. The latest information has it that the purchases will be executed not by ECB itself, but through the individual central banks in every Eurozone member state. Understandably, those national banks will buy state debt issued in the past by their sovereign and held by the country’s lenders.

On member state account

The latter institutions are certainly amongst the so-called 130 Eurozone systemic banks. It’s a fact that all major European banks have acted for decades as the preferential buyer of debt paper issued by their sovereign. As a result all the 130 major Eurozone lenders are stuffed with government bonds and will be the first to participate in this new €500bn program. So, it’s more than certain that those billions will end up in the coffers of Eurozone’s systemic banks.

However, everybody knows that those lenders very badly need new capital. The ECB itself has ascertained that last year while performing its famous stress tests on those 130 major Eurozone banks. The results were made public in November and the banks were given tight deadlines to raise more capital. The banks have only two ways to increase their principal. They can either attract more investors or increase their profits and capitalize them.

What will the banks do?

What then, if the banks use this €500bn of new cash in their vaults or large parts of it to play their own tricky games and try make a swift and large profit by ‘investing’ this money to the risky business of all kinds of derivatives and CDSs? Unquestionably, the ECB expects the lenders to use this extra cash to help the real economy start investing again and create more jobs. But are there the means to control what the banks will do with this new money? Rather not.

In any case there is a strong possibility, that a part of this newly acquired liquidity will be used by the banks to finance private investments in the real economy and digital economy. Such projects can also pay handsome returns to banks. Nonetheless, the ECB’s new program has one more major target; it can indeed help reduce the interest rate governments are paying for their investment borrowing. If this will be the case, some public projects which were rendered inefficient by the high cost of money, may now become runnable.

ECB’s mandate

Undoubtedly the new ECB’s extraordinary action to buy government debt in the secondary market is a drastic monetary tool to wake up prices and bring the inflation index close to the institutional level of 2%. This said, the new monetary measure appropriately falls within central bank’s mandate, which dictates that the ECB has as its main task to make sure inflation is close to 2%. Berlin is not right to insist that the ECB must intervene only when inflation is above that level. Negative inflation is also a problem for the ECB to solve. Just last week the Advocate General of the European Court of Justice, Cruz Villalón, concluded that a similar program realized by the ECB in 2012 the famous ‘Outright Monetary Transactions‘ is compatible with the Treaty on the Functioning of the European Union. Yves Mersch, Member of ECB‘s Executive Board, celebrated this legal opinion of the Advocate General of the European Court of Justice in the OMT case

A falling prices spear, as the one that Eurozone presently suffers of, is a much worse problem than an inflationary prickle. As things stand now in Eurozone, there is no other monetary policy to reverse the falling tendency of consumer prices than more quantitative easing, through government debt purchases by the ECB. It will also help revive the real economy in more than one way. Last but not least, it will moderate the foreign value of the euro, thus helping the euro area economy export more products and services and grow and create more jobs.

There is no doubt that the new ECB program must go ahead. Eurozone has already lost years waiting for Germany to understand, that there are many countries in Eurozone which cannot operate at inflation rates around zero. The rest of Europe cannot continue subsidizing the huge German reserves with positive real interest rates. When inflation is negative or zero, real interest rates are substantially positive even if their nominal levels are also close to zero. That’s why Eurozone needs some more inflation in order to revive its stagnating economy and alleviate its debts.