The Great Debate

from James Saft:

Waiting for Europe’s QE to sail

J Saft

Dec 2, 2010 10:17 EST

The good news is that the European Central Bank will probably start a massive additional round of quantitative easing to fight the break-up of the euro zone.

The bad news is that they will, as ever, only choose the right policy, as Winston Churchill said of the Americans, after exhausting all of the alternatives.

Global share markets rallied furiously on Wednesday, fed by hopes that the ECB would increase its bond-buying efforts, a possibility raised by its chief Jean-Claude Trichet in an appearance before the European Parliament. Trichet faces stern opposition inside the ECB from fellow central bankers, notably German Axel Weber, who believe that policy should be normalized rather than loosened.

This opposition, in combination with an unsure political climate, means that euro zone authorities will probably continue to try to buttress, enlarge and formalize the bailout mechanism while trying to maintain the fiction that something approaching normality reigns in European money and bank funding markets.

Why would QE be used to fight the break-up of the euro zone, now being widely discussed as the crisis spreads to ever larger member states?

Because QE, or really we should simply call it the monetization of government borrowing, offers some hope of easing the austerity now being imposed on Ireland and soon to come in Portugal and Spain.

Europe has made a choice to not allow member states to default or to allow their weakened banks to default, as default would threaten banks elsewhere. That leaves weakened economies carrying a crushing amount of debt, debt they will attempt to repay by budget cuts. This is a recipe for an economic death spiral, as a smaller and smaller economy becomes less and less able to shoulder its debt service.

Euro zone faces QE2 pain test

James Saft

Oct 14, 2010 09:23 EDT

QE2 — a second round of quantitative easing — means that soon the U.S., Japan and Britain will all be busily exporting their deflation, raising the question: Just how much pain can the euro zone take?

If by November we have three of the largest economies printing money and buying up their own debt, the outcome — in fact the intention — will be to drive their currencies lower against their trading partners, opening new international markets for their goods and, by raising the price of imported goods, fighting deflation before its debilitating psychology can take hold.

That is the plan, at any rate, and, unless something else happens, it will force the euro up against all major currencies, including, as it is tied to the dollar, the Chinese yuan. The euro has risen about 9.5 percent against the dollar in the past month, a trend that ultimately will murder European exporters and its stock market.

For reasons of history, society and sheer cussedness, the European Central Bank does not seem inclined to join in, though as usual there is dissension.

Speaking in New York on Tuesday ECB President Jean-Claude Trichet said that the ECB’s own version of QE, buying bonds of euro zone weak links and other liquidity support, will continue as planned at least until the end of the year, at which point, “We will see.” In contrast governing council member Axel Weber, speaking in the same city on the same day, pointedly called for an end to special measures immediately, saying the risks do not justify the benefits.

Forcing Europe to absorb more of the global deflation is really nothing more than a “back at ya” by the U.S. and others. Europe, in deciding to cling to its currency union and impose austerity on its weaker members, was doing exactly the same thing; exporting deflation, both in terms of a weaker euro and through the desperate actions of Greek and Irish residents who will consume less and must export more.

So, why won’t Europe simply power up its own printing presses and join the currency debasing party? In part it is a matter of history; the old Bundesbank horror, bred in the bone, of the inflation that devastated Weimar Germany.