ECB Policy

Draghi is passing the buck

EZB-Präsident in Irland
Is that a shirking smirk? Source: DPA

There he was again, the magician of markets. Shortly after Mario Draghi announced last Thursday that he would continue to flood the financial world with bond purchases for at least nine more months, Germany’s DAX index reached a new all-time high. It was a clear signal from Mr. Draghi, the master of ceremonies, that the party in the markets could continue.

The media reacted differently. There was much talk of the president of the European Central Bank (ECB) having heralded the end of cheap money – is that really true? Not when you look at the facts. Draghi is halving the ECB’s monthly purchases of government and corporate bonds to €30 billion ($35 billion) starting in January. The purchases will continue for at least nine more months. Afterwards, he can do what he wants – slow, prolong or even increase them. And interest rates? Mr. Draghi wants to leave them at zero long after the bond purchase program has ended. The ECB probably isn’t going to raise rates until the end of 2019.

In other words, last week’s announcement was the opposite of a decisive turnaround. The state of emergency in European monetary policy is far from over. Mr. Draghi has not abandoned the radical policy of supplying the markets with more and more cheap money. The ECB continues to buy at a lively pace, even though it’s already added government and corporate bonds worth €2.3 trillion to its books.

DAX knackt 13.000 Punkte
This tells you that Germany's DAX equities index is high. That's Draghi's fault. Source: DPA

It’s a breathtaking number, representing 40 percent of economic output in the euro zone. By way of comparison, the Fed has only about half of this figure on its balance sheet. As Bundesbank President Jens Weidmann puts it: The ECB is not stepping on the brakes, but is at best taking its foot off the accelerator.

Mr. Draghi, the procrastinator. To avoid causing panic in the financial markets, he keeps delaying the ECB’s phase-out of its ultra-relaxed monetary policy. But general economic conditions in the euro zone have been clear for some time and inflation is at 1.5 percent, no longer too far removed from the central bank’s 2 percent target. Mr. Draghi himself has said that the danger of deflation, which has been conjured up for many years, has long since been averted. Besides, the economy in the euro zone has clearly recovered. According to the Organisation for Economic Co-operation and Development (OECD), growth on the European continent is likely to surpass that of the United States this year.

But as the new record high levels on the DAX on Thursday and Friday showed, investors love Mr. Draghi. Many English-language media outlets have cited the positive market reactions as proof of how masterfully Mr. Draghi has managed his ultra-slow phase-out of an ultra-relaxed monetary policy.

The more Europe consumes the drug of cheap money, the more painful the withdrawal will be afterwards.

However, this market fetish is fatal. The ECB’s radical monetary policy has led to significant exaggerations in markets everywhere. This applies not only to equities and real estate, but also to bonds, which are being dangerously manipulated by the ECB’s purchases. As long as the central bank continues to buy bonds while simultaneously suppressing interest rates, this gigantic bubble will continue to inflate.

Of course, investors will always prefer low interest rates as well as a central bank that drives up valuations by buying securities. But this not only shifts the problems to the future, it also expands them. The more Europe consumes the drug of cheap money, the more painful the withdrawal will be afterwards.

The only thing that still justifies the ECB’s high-octane monetary policy is the high level of debt in European countries. Quite apart from that, however, reducing the interest burden on European countries is a far cry from the ECB’s mandate. Here, too, a continuation of the policy pursued to date only postpones, and tends to exacerbate, the problems. Over the past decade, the debt burden of the 19 euro countries has shot up from 65 percent to 89 percent of annual economic output. Most of this is attributable to the consequences of the financial crisis. However, government debt has also continued to rise between 2011, when Mr. Draghi came into office, and today, despite a tremendous reduction in the interest burden.

Mr. Draghi’s term ends in the fall of 2019, and it is highly likely that he will not have raised interest rates before then. The fact that he does not want to be the one who forces politicians to finally address their shortcomings by applying the pressure of higher interest rates is certainly human. But the solution cannot be to simply leave these painful and necessary steps to his successor.

Daniel Schäfer is head of Handelsblatt’s finance pages and is based in Frankfurt. To contact the author: d.schaefer@handelsblatt.com

 

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