Mario Draghi’s statement of last Thursday from Malta that the European Central Bank’s “monetary policy accommodation will need to be re-examined at our December monetary policy meeting”, offered a strong support to all major capital markets, with stocks gaining a lot of ground and the euro receding slightly. Understandably, a generous increase of ECB’s monthly asset purchases currently set by its Governing Council at €60 billion is the best news capital markets could expect from Frankfurt, where the central bank is located.
On top of that, a re-examination of monetary policy accommodation may also mean a reduction of the three basic ECB’s interest rates, one of which is already negative. In short, all that means more free money for the banks directly from ECB’s printing machines. Not without reason then the euro fell against the dollar last week. This was a first corollary of what Draghi said in Valletta.
The €1.14 trillion is not enough
To be reminded that as from last March the ECB has introduced an extraordinary monetary policy program of €1.14 trillion, which is meant to support the stagnating Eurozone economy and revive the fading inflation rate, currently at the negative part of the chart. Under this program the ECB distributes €60 billion a month to banks, through purchases of mainly euro area government securities. It will last until September 2016, or beyond, if necessary. According to Draghi, it will last “…until we see a sustained adjustment in the path of inflation that is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term”.
Despite this bonanza of fresh money delivered to banks, the inflation rate remains in the zero region and in September it crossed to the negative zone with -0.1%. Well informed sources say that the ECB’s services predict a continuation of the falling inflation rate tendency. Most probably that’s why Draghi announced a possible revision of ECB’s quantitative easing program, undoubtedly meaning a further and more generous increase of free money handouts to banks. Let’s dig a bit deeper on that.
Good money is cheap money
During the past few months, Eurozone experienced two important developments. Firstly Greece decided this summer to do whatever it takes to remain in Eurozone, thus ending a six month-long uncertainty about the unity of the single currency union. Secondly, the euro area inflation rate started falling again. Both those facts had double-edged consequences. In principle, both of them are positive, but they had some very negative side-effects. The euro started to become more expensive, thus undermining many member states’ efforts to gain a growth path through increased exports. On top of that, the falling inflation rate revived the fears of deflation and in any case it pointed to the opposite direction in relation to ECB’s target for inflation close to 2%.
In short, the rising parity of the euro with the other major world currencies started to significantly threaten the flimsy recovery of the Eurozone economy. Add to that the said estimate by the ECB services, that over the medium term inflation will fall deeper in the negative zone, and one comes up easily with an explanation of why Draghi announced a possible strengthening of “the degree of monetary policy accommodation”.
Everybody wants more free money
The reaction of the capital markets is an additional indication that in December the Governing Council of the central bank will raise the speed of the money printing machines. And this time the usually conservative Germans will not object to it for a very good reason. The Deutsche bank, one of the largest recipients of ECB’s free money is in great trouble. The largest German bank announced losses of €6.5billion in the third quarter of 2015. This is just the upper part of the iceberg of problems the German financial giant is facing.
There are reports that Deutsche sits on a mountain of risks in the grey and the white derivatives markets amounting to €72 trillion, that is many times the GDP of its home country. Obviously, Berlin with all its accumulated wealth cannot save Deutsche Bank, if the strong winds of a new crisis start blowing. Of course this is not just a German problem but rather a problem of the entire western financial system. The truth remains however that, given this fact, Germany cannot boast any more as the champion of financial orthodoxy. Behind closed doors Berlin must have received some strong blows coming from everywhere in the world and being asked, if not forced, to repent.
The Germans also need it
The obvious path for the Germans to do so is to let, if not beg, the ECB to print more money for everybody, within and without the euro area. This new money storm is the only way the Deutsche Bank can be saved by receiving a good part of the new print. What about the size of the new money bonanza the ECB may print?
The €1.14tn the ECB has posted is nothing compared to the $4.5tn the US central bank, the Fed, has printed and distributed to the American banks in order to save them and the world from the last financial Armageddon. If the long contemplated and quite risky increase of Fed’s dollar interest rates is not counterbalanced by more euro at zero cost from the ECB, the western financial banking system may crash. Understandably, the Fed will increase its interest rates only after the ECB has announced its new monetary policy tools.
The ECB will certainly act
Given all that, it’s rather certain that the ECB is about to greatly strengthen its monetary policy accommodation program or even introduce a new one. According to market sources, this new stimulus will also include interest rate reductions, despite the fact that one out of its three basic rates is already negative. The targets are many. From the European perspective the ECB wants to revitalize the Eurozone economy with abundant and cheap money and at the same time suppress the parity of the euro with the dollar. By doing so, the euro area central bank is set to supply the shaky Eurozone banks, with the needed zero cost liquidity so as they can recapitalize themselves, through increased profitability. This is exactly what happened at the other side of the Atlantic Ocean from 2008 to 2014.
It’s like a drug
Last but not least, the global financial system needs a substitute source of abundant and zero cost liquidity, after the American Fed stopped feeding it last November with more cash and now contemplates to increase the dollar interest rates. However, all the major western banks are addicted to free of charge money from their central banks. Then they lend it out or ‘invest’ it on the gray financial system, thus pocketing super profits to the detriment of the real economy. If their bets fail and go bust they just ask for more money. This is the way the global financial system functions nowadays and the ECB has to assume the Fed’s job, because the dollar cannot support any more printing.
For all those reasons, the ECB will certainly change its monetary policy accommodation in December and the first visible result will be a cheaper euro.