The financial crisis is back. Nearly eight and a half year after the first tremors of the subprime crisis, global stock markets are plunging again. The health of banks is of concern, as is the real economy. For most observers, the case has been tried. This new implosion has one and only one designated culprit: central banks and their accommodative policies of “Quantitative Easing.” Economists assure us that pouring billions of dollars, euros, pounds and hundreds of billion yen fueled a bubble in the markets, which later burst. By imposing negative rates, supposedly, central banks attenuated economic results.
This explanation is not entirely wrong. The quantitative easing policies of the Fed, the Bank of England, the Bank of Japan and the ECB certainly poured huge amounts of liquid capital into the markets. But their distribution in the real economy has been slower, and lesser. The major banks have therefore supplied a powerful current that has caused Chinese importers difficulties and the already slowing European growth has slowed even more sharply. This actually began last August, with the first “devaluation” of the Chinese yuan.
The two errors: 2008 and 2010
But this explanation is also incomplete. This new wave, remember, is only the continuation of the great 2007 crisis – the crisis of deregulation – finally reaching its completion. The bankruptcy of Lehman Brothers on September 15, 2008 led the financial system to the brink of the abyss, and the “rescue” of Greece’s loan payments on May 10, 2010 plunged the Eurozone into economic turmoil from which it is only just emerging. In both cases, the error came from mostly oblivious governments, eager to manage their short term politics (one remembers the obsession of Angela Merkel with regional elections in North Rhine-Westphalia in 2010) while locked into economic policies based on market efficiency.
In 2008, the United States wanted to “make an example” of Lehman Brothers by showing that the state would not come to the aid of those who took excessive risks. The market would play its role as “purifier.” In 2010, EU leaders who applied this Ricardian theory had to quickly restore the public accounts of nations affected by the crisis in order to restore market confidence and economic agency. That example was also an attempt to “punish” those who had spent too much, making them suffer the consequences of the imbalances they were supposed to have created. In both cases, these decisions were immeasurable disasters. Central banks then had to intervene as “safety nets,” saving what could be saved. The ECB, however, was the least determined to act. Jean-Claude Trichet of the ECB had twice in this crisis raised rates, in July 2008 and in July 2011, but it was not until Mario Draghi succeeded him that firm action began to address the European crisis. It is not accidental that the ECB was the last to embark on quantitative easing, and it is not accidental that the Euro area has been the hardest hit by the crisis since 2007.
The mistake of European authorities
Central banks have therefore acted as firefighters. No doubt they were also partly arsonists, but why did this change take place? Because they failed to actually revive growth prospects and address inflation. This failure is not only that of central banks, but also a failure of governments that have relied solely on monetary policy to do the work of recovery while it actually did the reverse. The example of the Euro area is, from this point of view, very telling. Between 2010 and 2014, governments and European authorities including the ECB have led with a policy focused on fiscal consolidation and “structural reforms” aimed especially at reducing labor costs. These clearly deflationary policies have ruined the European potential for growth and destroyed confidence in a future they have yet to establish. The result has been instead a steady decrease in inflation.
Since October 2013, the annual core inflation, excluding food and energy, has only once exceeded 1%: it was 1.1% in October 2015. In these conditions, expectations of inflation have fallen and when inflation expectations recede, the incentive to invest is zero. However, with other policies the Euro area can experience real recovery without recovery in the investment field.
The global effects of European policy
Moreover, this European deflationary policy has had other repercussions. Reducing European growth sustainably, it has relied on exports to several countries, such as China. For political reasons, however, the second largest economy in the world as attempted to contain its production levels while accelerating its economic policy of being less dependent on the outside and increasing demand for domestic goods and services. These two forces led to a Chinese industrial overproduction and an explosion of debt in the Middle Kingdom in 2012. But once the Chinese economy had found its inevitable adjustment, growth slowed, resulting in lower commodity prices (already caused by the decline of European growth) and a decrease in Chinese demand for imports. Thus there were two consequences for the Euro area: a further decline in inflation and a slowdown in economic prospects. For Germany, for example, the Chamber of Commerce has just revised its projection of the growth outlook for 2015 to 1.3% (as opposed to 1.7% projected by the government).
The warning from Mario Draghi
Given such circumstances, central banks had to act again (except the Fed who seems nevertheless unwilling to reverse its tightening policy). But their policies can not replace the lack of prospectives for economic agents. They can facilitate demand, not create it. Yet they need to create. When Mario Draghi of the ECB planned to dive into the deep end of QE on August 22, 2014 in Jackson Hole, he said he would do so only if it helped: that if, in addition to the ECB, there was a growth policy throughout the Eurozone, comprising a true recovery. The idea was simple: by increasing the demand, states would stimulate their economies and create opportunities for the funds released by the QE. But he was met with a late confusion. Wolfgang Schäuble, at the time, had assured ECB they had “misunderstood Draghi.” To satisfy the crowds, it had launched a “Juncker plan,” similar to the 2012 “growth pact” of Francois Hollande, which has been lost in the sands of Brussels. Instead of stimulating the national economies, QE has only fueled another speculative bubble.
What the accommodative monetary policy helped to avoid
It should not be forgotten that central banks have prevented the establishment of a deflationary cycle. QE made a point of addressing 2015 inflation in the Eurozone. Without it, inflation had been -0.8%, which would have triggered certainly a deflationary spiral in which not only would investment halt, but in which wages and employment would have to be adjusted. Such a spiral is one of the worst economic dangers, one from which it is very difficult to extricate an economy — the Japanese cases continue to prove it. The action of the ECB in 2014-2015 was therefore essential, as it was in 2008 and 2012.
But, like any medicine, it has side effects. An accompanying action by the nations or the EU could reduce these effects by allowing better transmission to the real economy. Instead, they preferred the facade: they would do nothing, in order to save a budget reduction policy that is supposedly effective but that proves absolutely useless against recession. Even worse, states like France have long relied on only central bank action to bring back growth, not taking seriously the warnings of Mario Draghi that such monetary policy cannot create growth.
Fall guys?
The responsibility of central banks is therefore that a lamplighter. The real culprits are the national and European authorities who continue to maintain a deflationary policy while refusing any real policy of active stimulus. Central banks, the ECB in particular, have remained content with the means available to them. After all, they did not start the fire, nor are they keepers of the flame. Their inaction stems from the passivity and ideological blindness of States. Today we suffer its consequences.
Accusing the central banks as though they are the only ones responsible is not accurate. In fact central banks have been the only ones to really show courage, initiative and innovation to deal with the last single scale crisis. It has been argued that the market would have, without their efforts, achieved a less painful adjustment. But this is lip service: the experiences of 2008 and 2010 prove otherwise. The European economy – and the world – has too long paid for empty words. The global economy thirsts for real inflation that can only come through a policy to boost investment and increase wages.
