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How far is the ECB going to go?

Written by Taco te Gussinklo | 5 minutes
FRI 27-09-2019

This is a question that bubbles up when we look at what is happening in the market right now. The investors - actually worldwide - follow the statements of the Central Bank presidents very closely. Sentences are dissected word for word and then weighed on a scale for meaning. Does it look like the interest rate is not being raised or that new incentives are coming? The stock market is going up. Has this been invested in 2019?

The individual operating results are important, it is the Central Bank presidents (Kuroda from Japan, Yellen in the US, Draghi in Europe and Mark Carney in England) who set markets in motion. How did it come to this?

The big recession.

The period 2008 - 2009 is seen as the major recession. It started in America as a sub-prime crisis, changed shape to credit crisis to become a banking crisis. In Europe, it was the Euro crisis. During this period, the Central Banks had a relatively loose monetary policy. The main lesson from the big depression at the beginning of the last century was that the system needed liquidity in order operate. That is what has happened. First in the form of credit facilities and emergency funds which eventually resulted in Quantitative Easing (QE) . The ECB has also started this, albeit relatively late compared to America.

The fact that the global monetary system needs money in a turbulent period is something that most economists agree on. But how much? And how for long? When do you stop? And how do you stop? All good questions, but unfortunately the answers are not clear at this stage.

What is QE

This is the process of increasing the money supply by a central bank by buying up government bonds. The intention is that the banks lend the money they receive for these government bonds to companies and individuals to encourage them to invest and consume. This is good for the economy. An additional effect of a (potentially) larger money supply is inflation. And the primary objective of the ECB is price stability with inflation of just under 2%. What must be prevented is deflation. This can lead to consumers delaying their purchases. In addition, deflation is negative for people, companies and governments with debts. Where a debt with inflation becomes less 'heavy' every year, the debt grows with deflation.

The cash press is not encouraged by quantitative easing, although it is often said this way. Although the ECB buys government bonds from banks and transfers the amount to them, the money has not yet entered the real economy. The bank now has money that it can lend out. But if the companies and individuals do not borrow the money it is a paper transaction and there is still no money 'pumped into the economy'. And inflation also does not run out.


Furthermore, an important aspect of QE is that the government bonds must be repaid by the government. The government bond bought by the ECB is therefore not waived by the ECB.    

Will the ECB continue?

If the situation does not improve, it is not inconceivable that the ECB will consider taking further measures to boost growth. Although there was already a lot of resistance - especially from the northern Member States - against QE, Mr Draghi was in the right. The European Court has determined that the ECB will remain within its mandate with the QE purchase program. So what the ECB is doing at the moment is allowed. This also means that the mandate of the ECB may be stretched a bit further. But what possibilities are there? There is actually one and that is monetary financing.


What is monetary financing?

With monetary financing, it is the central bank that finances a government directly. The government can therefore make investments without making debts. After all, these debts are for the central bank. So this is the big difference with QE. In the case of QE, government bonds are bought by the central bank, but these are simply repaid by the government that issued the bonds. With monetary financing you do not have to pay back and you could say that "money is being pumped into the economy". Furthermore, monetary financing is not good for the balance sheet of the central bank. That weakens because there is no claim or asset in front of the issue. So monetary financing is of an entirely different order than QE.  

Monetary funding is not allowed within the European Union. And there are good reasons for that. The first danger is that the government does not pay attention to its expenses and continues to expand. After all, money is no problem. The second problem is the fact that the central bank can lose its grip on the amount of money in circulation. This could lead to significantly higher inflation while the main objective of the ECB is price stability. And that higher inflation leads to rising interest rates, making it even more attractive to finance the new government expenditures through more money from the ECB. In short, hyperinflation is lurking. In Venezuela, for example, this is the case. According to the IMF, inflation will tap 480% this year to rise to over 1,500% in 2017. Hyperinflation also played in Germany in 1923 and recently in Zimbabwe (last official inflation figure of the government in July 2008 was more than 230,000,000% inflation.


Helicopter money

A variant of monetary financing is "helicopter money". The term actually speaks for itself .... Of course, money is not literally thrown out of a helicopter. It is rather the case that the money comes directly to the account of the private individuals. (I leave the legal and practical aspects completely out of consideration). But the question is what the citizens will do with it? Are they actually going to spend it? Or are they going to pay for savings or debts? Of course, the latter is also conceivable. "A world in which the money is free has gone completely crazy and will probably become even crazier. I'd rather keep this money for even stranger times. "

In short, if they did not publish it, nothing has yet been won. Consumption does not increase.

The latter would almost call for monetary financing of government investment to be preferred over helicopter money. The government will actually start investing and whether private individuals are going to invest is still a matter of waiting.   

What now?

It is good to repeat that monetary financing is not allowed within the EU. The dangers are (too ?!) great. This does not alter the fact that the 'helicopter money debate' already going on will be further expanded. (It has already been proposed by 18 members of the European Parliament to Mr Draghi in a letter). The rationale for this will be that the current measures have too little effect.                                                                                           


Taco te Gussinklo

Taco was an active investor with BinckBank before he joined the team. He also writes finance columns for several magazines and websites. “Investing becomes much more interesting when you have enough knowledge. When I investigate my columns I always find a subject that will be useful to our investors so that they can put it into practice.” 

The information in this article should not be interpreted as individual investment advice.  Although BinckBank compiles and maintains these pages from reliable sources, BinckBank cannot guarantee that the information is accurate, complete and up-to-date. Any information used from this article without prior verification or advice, is at your own risk.  We advise that you only invest in products that fit your knowledge and experience and do not invest in financial instruments where you do not understand the risks. 

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