If there has been one constant since the global financial crisis began in 2008, it’s that central bankers will be the first to soothe market fears.
And so it was last week. As stock markets plunged globally, sparking fears of a return of the euro zone crisis, it was the U.S. Federal Reserve, the European Central Bank and the Bank of England that stepped into the breach, assuring investors that the days of easy money may not be over just yet.
The promises helped spark a rally in global stock indices on Friday.
The danger is that this reprieve will be temporary. Indeed, European stocks already gave back some of Friday’s gains on Monday morning, with Germany’s DAX index falling more than 1 per cent as of 12:00 CET.
The latest market volatility suggests central banks may no longer be able to mask the fundamental problems in the global economy, especially those in Europe. Many southern European economies remain uncompetitive and highly indebted compared to their northern counterparts. Money has once again started flowing out of the former and into the latter.
“The capital markets have long adhered to the theory that this is a temporary crisis, one that can be corrected with a lot of money. This belief is now evaporating,” said Hans-Werner Sinn, president of the Munich-based Ifo Institute for Economic Research and a long-time critic of central banks’ accommodative monetary policies.
“Even at a global level, the problems cannot be covered up with money over the long term,” Mr. Sinn told Handelsblatt.
“The ECB’s ‘whatever it takes’ to keep the euro together still holds.”
Imbalances in Europe are growing at the fastest pace since May 2012. Capital is flowing out of Italy in particular and into Europe’s largest economy.
In Italy, which is expected to fall back into recession this year, some €67 billion ($85 billion) flowed out of the country in August and September alone – much of it coming to Germany. The Bank of Italy, the country’s central bank, now owes just under €200 billion to other European central banks, according to the intra-European payments system known as “Target,” which serves as an indicator of imbalances in the 18-nation currency bloc.
By contrast, the German central bank, the Bundesbank, saw its surplus in the Target payments system increase by €36 billion ($46 billion), or 8 percent, to €480 billion over the same time frame. German banks, meanwhile, are drowning in money – the total amount of deposits has exceeded total lending twice already this year, according to new data provided exclusively to Handelsblatt.
These imbalances likely grew further in October, said Richard Werner, a professor of international banking at the University of Southampton. He also cited the decline in yields on German 10-year bonds to a record low of nearly 0.7 percent last week as a further sign of capital flight into Germany, which has long been considered a safe haven in times of crisis.
The last time there was large-scale capital flight from Europe’s crisis-ridden countries into Germany was about two years ago. That prompted European Central Bank President Mario Draghi, who felt the continued existence of the euro currency was in jeopardy, to give his now-famous promise to do “whatever it takes” within the ECB’s mandate to save the euro.
With that promise, the crisis was averted and money began flowing back into the southern European countries. The Bank of Italy saw its Target debts decline by nearly €160 billion between autumn 2012 and July of this year, while yields on government bonds across the euro zone declined significantly.
Ifo’s Mr. Sinn argued that such measures to combat the crisis have only addressed symptoms in the financial sector, while failing to account for the underlying economic causes. “Industry in Spain and Italy is no longer competitive,” he said.
With Italy, in particular, there has been a clear reversal of expectations for economic development. “Instead of growth, we now anticipate a decline in economic output this year,” Mr. Sinn said.
“The capital markets have long adhered to the theory that this is a temporary crisis, one that can be corrected with a lot of money. This belief is now evaporating.”
And yet, it was central banks that once again managed to hold the system together last week. James Bullard, head of the Federal Reserve Bank of St. Louis, said the U.S. central bank should consider delaying plans to curb its bond-buying program. Andrew Haldane, the chief economist of the Bank of England, also signaled that interest rates in Britain could remain “lower for longer.”
The central-bank effect counts for Europe, too. Christoph Weil, an economist with Germany’s Commerzbank, said the key difference between now and 2012 remains Mr. Draghi’s promise. Expectations that the ECB will take further measures to address the situation should calm markets in the coming weeks.
“The ECB’s ‘whatever it takes’ to keep the euro together still holds,” Mr. Weil told Handelsblatt Global Edition. While the increase in Target imbalances is “certainly an indicator” of a flare-up of the euro crisis, “we expect the ECB to take further measures” to control the situation, he said.
Benoît Cœuré, a member of the ECB’s Executive Board in Frankfurt, said Friday that the central bank will begin buying asset-backed securities in the coming days. Most economists now say that additional measures, such as a U.S. Federal Reserve-style quantitative easing program to buy up government bonds, could also be on the horizon.
And so the glut of easy money continues.
Norbert Häring is a Düsseldorf-based economist and editor for Handelsblatt. Christopher Cermak covers economic and financial issues out of Berlin for Handelsblatt Global Edition. Heinz-Roger Dohms and Meike Schreiber also contributed to this story. To contact the authors: firstname.lastname@example.org and email@example.com