We’re all guilty of criticising central banks now and then. Some more than others. We blame them for the ills afflicting the global economy. For the wave of credit expansion that’s left economies drowning in debt. And while they’re often deserving of this flack, sometimes the criticism doesn’t stick.
It’s rare that we can sit back and say that. But yesterday was one such occasion where we could justifiably do just that.
Overnight, European Central Bank (ECB) President Mario Draghi sent shockwaves through global markets. It’s not so much what the ECB did, but what it didn’t do that was the problem.
After promising in November to ramp up credit expansion this month, ‘Drags’ disappointed everyone.
The ECB announced it would continue its €60 billion a month bond buying program. More commonly known as quantitative easing (QE), Draghi indicated the program would now run through to March 2017. On top of this, he announced another rate cut to a historic 0.3% low.
In any normal world, this would be an acceptable compromise. On the one hand, it’s an admission that Europe still needs QE. But it also knows that more QE would have little benefit for the euro area economy in the long run. It hasn’t up to this point, so why would this time be any different?
But the ECB also can’t end the program altogether for two simple reasons:
- The European economy remains fragile. It’s in the ECB’s interest to ensure the situation doesn’t worsen.
- Investors would chuck a proverbial hissy fit if the ECB ended QE.
In keeping QE unchanged, the ECB found a middle ground of sorts. The program remains the same, only with an expanded timeframe. Sounds like good news for investors, right? Nope.
Investors aren’t stupid. They want to make money. And they’d prefer not to lose any if at all possible. That’s not only understandable, but perfectly acceptable.
But they’re also being short sighted. Investors need to take stock of the pressures facing the global economy. Growth isn’t easy to come by, with or without credit expansion. Hosing down expectations, to match the reality of slowing growth, would be a start.
In any case, the ECB’s decision left investors in a bind. And markets being markets meant panic ensued. The euro rose, as European and US stocks plunged.
Markets were expecting the ECB to expand the QE program by a third. Instead they got more of the same. You can understand why investors might’ve believed that. In November, Mario Draghi said the ECB would ‘do what we must to raise inflation as quickly as possible.’
And instead, the ECB lowered interest rates. That came as a major disappointment for investors. Those that sold euros, and bought into stocks, were left reeling. After all, they believed that QE would expand, not stall.
Needless to say, they thought wrong. Now investors are looking to shift their bets. Which explains why the euro climbed to US$1.09 overnight. The panic also forced down European stocks. French and Germany markets lost 3.6% on the back of Draghi’s announcement.
Are the ECB to blame, or do we blame investors?
You have to question who the biggest idiot is in all this. And while it’s hard to beat the central banks in the stupidity stakes, markets give them a run for their money.
Why would anyone still take a central bank on its word? Who knows. It’s mystifying. After the endless lies and failed promises, central bankers ran out of credibility long ago.
So investors should take a long, hard look at themselves. Why did they believe the ECB would expand QE? Why did it listen to them, and make investment decisions based on it? Central banks have fooled markets so often that it doesn’t come as a shock anymore.
This is why we need to cut the ECB some slack. We should be thankful that it didn’t juice up the European economy. Or at least not as much as markets were hoping for. You don’t tell a smoker to quit by smoking more. Yet that’s exactly what markets seem to be demanding of the ECB.
This next quick fix response is wilfully ignorant of the damage it’s doing in the long run to economies. The growing imbalance between financial markets and real economies is a concern. And more QE will only worsen the problem.
Yet, like a boomerang, the economy has a way of coming full circle. When an economy can’t sustain new credit, or debt, expansion anymore, it folds in on itself. Central banks have already tested the limits of this. Which is why when interest rates can’t go any lower, they resort to QE.
As credit expands, asset bubbles form. And they’re at risk of popping. Everything from stocks, to bonds, to property, risks crashing. And it’s all because of the easy credit that’s flooded the world since 2008.
In any case, the ECB should be applauded for not taking things as far as markets wanted. But let’s not absolve them too quickly. After all, the ECB did lower interest rates to record lows. And it did extend the existing QE program to 2017.
But markets must realise that what they’re demanding is harmful. Quick returns are pointless if the entire system implodes down the line.
Where does the Federal Reserve go from here?
After the ECB’s non-event announcements, all eyes turn to the Federal Reserve. The Fed meets on 15–16 December, and will decide whether to raise rates for the first time since 2006.
Markets are convinced the Fed will begin the rate lift off this month. Why? Because the Fed said so. The Fed has strung markets along like this all year. You’d think investors would’ve wised up by now. But like their European counterparts, US markets are irrational at the best of times.
There’s actually no guarantee that a policy change would result in a rate hike. It could just as easily develop into more QE. The Fed has already indicated that it’d be open to more monetary stimulus if push came to shove.
So the Fed doesn’t have concrete plans to hike rates. Even if it seems to be saying just that in public announcements. It’s open to anything, providing the conditions are ripe for it. And it certainly won’t tell markets what it really intends. Half the battle is surprising investors, as the ECB just did.
By no means are the central banks cleared of wrongdoing in all this. But they deserve credit when they don’t engage in damaging, speculative behaviour. Even when the markets want them to do exactly that.
Ultimately, investors need to get a grip and take stock of what’s happening in the world. We need less QE, and more sanity. And it wouldn’t go astray if investors stopped hanging on every last word of central banks’ either.
Junior Analyst, The Daily Reckoning
PS: Central bankers’ monetary manipulations are nothing new. It’s why half the developed world seems to have interest rates at near zero. But it won’t be long before Australia joins the club.
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