ECB’s new money bonanza handed out to help the real economy or create new bubbles?

Discussion between Mario Draghi, President of the European Central Bank (ECB), on the right, and Jean-Claude Juncker, Prsident of the European Commission. Location: Brussels – Council/Justus Lipsius. © European Union, 2015 / Source: EC – Audiovisual Service / Photo: Etienne Ansotte.

Last Thursday the European Central Bank announced it will pump extra piles of freshly printed money into Eurozone’s banking system. The President of ECB, Mario Draghi said that he will be delivering €80 billion a month for the public bonds owned by banks for as long as it is needed. On top of this, the ECB will refinance the banks with targeted injections of as much money as they want, through long term loans at zero interest rate.

It’s difficult to assess the full amount the ECB is to upload on the banking system during the next twelve months, but it should be well above one trillion. Market pundits say the ECB with its new extraordinary monetary measures has deactivated all backstops. Let’s see the details.

The long awaited meeting of ECB’s governing council of 10 March finally decided to abandon its cautious policy of gradual monetary easing, and opened wide all its coffers for the lenders to feast. In the face of it the ‘official’ rationale for this spectacular change of course is the negative inflation rate recorded last February at -0.2%. On top of that, the ECB staff macroeconomic projections for the euro area, foresee annual HICP inflation at 0.1% in 2016, 1.3% in 2017 and 1.6% in 2018.

Fighting low inflation

Given that, for years, inflation oscillates around zero, far below ECB’s target set at close to 2%, the ECB is justified to now release an extraordinarily generous accommodative monetary policy. Not to forget that the core of ECB’s mandate is to maintain price stability by targeting an appropriate inflation rate. To do this the central banks uses relevant monetary policy instruments and procedures.

In reality, the ECB has been rather too late in applying significant non-standard monetary policy measures, in order to fulfill its main duty of securing price stability. It’s not only that though. The ECB is now about to flood the banks with zero cost cash in order to help them recapitalize through profiteering on the real economy.

It’s always the banks

The system works like so; the banks lend the money they receive for free charging hideously high interest rates. In this way, they usurp the value produced in the real economy. That’s why this author observed here above that low inflation is just the ‘official’ reason for this money bonanza to banks. Everybody knows that the major Eurozone banks are dangerously undercapitalized.

Coming back to last Thursday’s decisions, Mario Draghi said the ECB will be pumping an extra €20 billion a month into Eurozone’s financial system. This will be realized by expanding the monthly asset purchase program from €60 billion at present to €80bn. This newly printed money will be handed out to banks against government or other public entity bonds they hold. Draghi added that the program will continue at least until March 2017 or for as long as it is needed to bring inflation back on course. One could add, and until the banks manage to get decently recapitalized.

Flooding the market

This asset purchase program is now twelve months long. On 9 March 2015, the ECB started buying public sector securities at a tempo of €60 billion a month. Up to now the program has accumulated a round sum of €750bn. The program will be extended now to €80 billion a month. Under it, the ECB is to spend at least €960bn until March 2017, but this is bound to continue “for as long as it is needed”. This means the €960bn are the down limit for this program for the next twelve months.

However, there is more money for the banks. This June, the ECB is to introduce another program to support the banks, called Targeted Long Term Refinancing Operations (TLTROs). Under it, the banks will be entitled to borrow the equivalent of up to 30% of the stock of eligible loans they had on their books on 31 January 2016 and, understandably, this will be at a flat zero interest rate.

By the way, last Thursday, the ECB lowered its key interest rate to flat zero from a meager 0.05%. As a result, from now on the banks will be able to refinance themselves from the ECB at zero cost. The interest rate on the money the banks deposit with the ECB is lowered by 10 basis points to -0.40%. Consequently, the Euribor (interbank interest rate in the London market) will be accordingly adjusted deeper in the negative region, further perturbing the money and capital markets.

All markets rallied

It seems though that the capital markets don’t mind much about that for as long as they receive free money. As expected then, all those groundbreaking changes were received in the stock markets with enthusiasm. It couldn’t be differently, since Draghi said plainly he is handing out to banks more free money. In any case, his extraordinary new package had a strong and lasting impact on every market. Even crude oil rebounded and together with it the energy shares gained a lot of ground.

As a result, all stock exchanges on both shores of the Atlantic continued rallying till late last Friday afternoon. This is a strong indication of what the banks will do with at least a large part of Draghi’s new money bonanza. They will for sure use it to create new bubbles in the capital markets. Predictably, only a part of it may find its way to the real economy, as new loans to consumers and businesses.

What next?

In conclusion, Draghi’s most recent and critical bet will be decided in relation to the extent the real economy is to profit. If the real economy won’t react strongly to cheaper money, the additional liquidity will just cause financial bubbles. And this time, the illusion will be much more dangerous than the last one. What if a new financial crisis surfaces and the ECB is left out of ammunition, having now almost exhausted its arsenal?