Authored by Jeffrey Snider via Alhambra Investment Partners,
It is like a great many things forgotten now, but five years ago today the head of the ECB compared Europe to a bumblebee. That’s not quite right, however, as Mario Draghi really said the euro was like a bumblebee, but you’d be forgiven for mixing the two up. The purpose of his folksy analogy was so that Europe and its currency might forever be interwoven, the two inseparable in fact as well as theory.
We are reviewing, of course, Draghi’s promise on occasion of its half-decade mark. Being in charge of Europe’s central bank at that moment in time was no easy job. The Continent was beset by enormous problems seemingly on all sides. Not even a year before, the European banking system nearly fell into its own Lehman moment (what was it that actually happened on December 8, 2011?), leaving the ECB to scramble up nearly €1 trillion in “liquidity” (LTRO’s).
And still it didn’t seem to be working. The banking crisis faded, as they always do, but the effects of it did not. By summer 2012, the euro seemed to be coming apart. The immediate problem was the euro’s apparently fatal tie between very different economic systems; this North/South divide, or PIIGS versus largely Germany. Peripheral European bond spreads had blown out, suggesting that there were deeper problems than simply short run liquidity.
On July 26, 2012, Draghi put himself in front of the cameras and declared to the world the euro would survive no matter what.
The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.
Was it? As human beings, we like to use the opportunity round numbers afford to take stock of things. And why not? Of big things there needs to be such accounting, and, if need be, reckoning.
On the basis of just peripheral bond spreads, at first glance the promise was a triumph. A more determined view would only give it qualified success. Peripheral spreads have collapsed when compared to the worst of 2011-12, but they have never normalized to pre-crisis conditions. There remains five years later a distinct premium (that rose again, importantly, in the global downturn of 2015-16).
A hundred and fifty basis points is not 600, to be sure, but it’s also not zero and that matters. Whatever it is that drives the differences from among these places remains in effect, if subdued. Because of this, and because of Draghi’s promise, further investigation is required on that narrow basis alone.
In the 21st century we often forget that there is a purpose to money. In many ways that’s understandable given the manner in which these kinds of things are presented for our understanding (especially in the orthodox sense). Money, as finance, has become a thing almost unto itself; a system of inputs dedicated to its own output. It is in that sense where peripheral bond spreads are often measured.
The euro isn’t supposed to be solely a currency for the standard conduct of financial purposes across Europe. Bond spreads do matter but in what they tell us about the primary conditions more necessary to fruitful social circumstances. Money is a derivative tool for economy and therefore overall social stability.
The ECB’s policy framework from July 26, 2012, forward was relatively simple in that respect. It would supply all required liquidity such that the business of money could go back to being the business of business. Remove those concerns about money, it was believed, and everything would go back to normal, or at least close enough to it that any further and necessary reforms or changes could be conducted under benign conditions. Regular economic growth solves almost all problems, or allows them to be solved with reasonable and limited disruption.
In economic terms, Draghi’s promise also comes in for qualified success. As European officials have this year become very fond of saying, real GDP for the EU has grown for 16 successive quarters. It has become for the Europeans nearly like the Japanese, where achievement is measured in the littlest amounts, the mere absence of negatives.
Given that the Continent in mid-2012 was gripped by “unexpected” re-recession, four years without renewal of it does seem to be something. But as we all have found out all around the world over the last ten years, cyclicality no longer applies. For an operating theory that counts on the clearing of monetary obstacles for the natural cyclical forces to be able to do their unfettered good, absence of cyclicality is not minor trivia.
In other words, monetary policy is almost always focused on the downside, preventing recession or the current one getting worse. Monetary theory has over the decades simply lost touch with the upside. It wasn’t necessary, economists believed, because the upside was the upside; a fact of nature. If you let go of a balloon filled with helium, or cut its string, you expect it to rise without any further exertion. That was Draghi’s promise.
If the balloon instead hangs at the same altitude, or even falls toward the ground, what do you do? That has been monetary policy in Europe ever since the promise; trying to make sense of what doesn’t make orthodox sense.
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What we find instead is that the biggest threat to the euro was not the North/South divide, but that the entire European economy was malfunctioning. In that way the focus on the PIIGS in the early aftermath of the Great “Recession” was actually misleading. The peripheral bond spreads weren’t suggesting that the PIIGS were at risk that Germany and the Netherlands weren’t. They were the leading indication of where this problem would be exposed first (the weakest links).
Once that became clear(er), the ECB in 2014 went insane. Not in a Weimar Germany sort of way that many people think about for QE and LSAP’s (large-scale asset purchases), but they leapt beyond all sense of prior propriety. As of the latest figures, under the three big current programs since that time, the ECB has purchased €1,961,374,000,000 in assets (€1.64 trillion under PSPP, or QE; €224 billion CBPP3, the covered bonds; €100 billion corporate bonds). It certainly seems as if we should be worried about hyperinflation, but even Mario Draghi can’t find where all that effort ended up.
At the ECB’s latest policy meeting, he admitted what should have been obvious last year, and the year before. The media, by and large, allowed itself to be fooled by oil prices into thinking the nearly €2 trillion in so-called stimulus was just delayed.
There really isn’t any convincing sign of a pickup in inflation.
How can that be? After €2 trillion there should be something easily visible in consumer prices. The relationship between money and prices is immutable. But it’s not just inflation where this “money” has gone missing, however. A broad survey of Europe’s economic and functional money situation displays a shocking incongruity. The ECB has done a lot but only for the sake of the ECB doing a lot. The European balloon just hangs there in suspended animation.
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European policymakers believe that they have cut the balloon’s tether, but whether of inflation, lending, or money markets it is clear one remains firmly fixed anyway. In that respect, Mario Draghi should have recalled his now five-year old bumblebee analogy.
The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does. So the euro was a bumblebee that flew very well for several years. And now — and I think people ask “how come?”– probably there was something in the atmosphere, in the air, that made the bumblebee fly. Now something must have changed in the air, and we know what after the financial crisis.
Or maybe they don’t know what after the financial crisis (and its ongoing aftershocks). The threat to the euro is today greater than it was in 2012, and for that Draghi has completely failed. It comes not in Target II imbalances and Greek default penalties, but in political upheaval tied directly to what it is that Mario Draghi can’t seem to figure out. He can promise all he wants, but Europe’s fate will not be determined by his euro.