Monday, January 26, 2015

How Quantitative Easing works | … and it does work

On Thursday last, in a momentous week for Foreign Exchange and all that goes with it in Europe, the ECB announced the commencement of Quantitative Easing in the Euro area.

I am grateful to the Wall Street Journal for the graphic above, explaining how QE is projected to operate. It applies to QE in the US, which has just ended, but the principle in the Eurozone will the same, except that the money redirected to the banks is expected to be used for business and consumption loans as well as for the purchase of stocks, corporate bonds and commodities.

… and it does work

Much commentary has been made about the measures announced last week. A lot of it is characterised by remarks that express doubts about if it will work, or the possibility of it being “too little, too late”.

Our opinion is that it will work, the amounts involved are appropriate, and now is exactly the right time for its implementation in the Eurozone.

The economies of both the UK and the USA, where QE has been a feature for quite some time, are now well on the mend. Much is made of the situation in Japan, where the economy is still struggling after many years of such monetary stimulus. But as Adam Carr has pointed out in the Australian “Business Spectator”, Europe bears no resemblance to Japan, in economic terms. The following is a short excerpt from his article:
“While … attention was given to Europe’s supposed debt problems, Japan’s were -- and are -- far more real and serious. Total debt (private and public sector) was around 460 per cent of GDP on 2012 figures. That might be closer to 480 per cent now. 
In contrast, Europe has a much more respectable debt position of 178 per cent of GDP -- that’s total public and private debt. There is, quite simply, no contest. Europe is not Japan, for the simple reason that unlike Japan, Europe can afford to pay off its debt. Japan in contrast has no reasonable hope of ever paying off its debt burden, especially with a shrinking economy and a shrinking population.
Consider that the euro area as a region runs smaller budget deficits that the rest of the advanced world, and in contrast to many other developed nations runs a current account surplus. This is an important fact. What it means is that Europe is effectively a lender to the rest of the world. It’s fair to say that Japan also runs a current account surplus, but let’s not beat around the bush: Japan’s biggest export is the money the Bank of Japan prints. It prints the money and then lends it out to the rest of the world. With much smaller deficits, much lower net debt and that current account surplus, Europe need only redirect some of the money that it lends abroad toward its own region. That is, if they were overly concerned about growth. But growth isn’t everything, as they say”.

With regard to the timing – if QE had been introduced earlier, at the time when similar measures were working their way through the US and British systems, the Euro area would simply have made itself part of a race to the bottom in global economic terms. It is precisely when American and UK monetary policies are each diverging from that of the Euro area that QE here will have the greatest effect.

We look forward to the EU, and the Euro, once again demonstrating that they have a resilience that has often taken commentators in other regions of the world, and even in Europe itself, by surprise.

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