The European Central Bank (ECB) has announced its own version of quantitative easing (QE). It will start buying 60 billion euros of assets each month, going well into 2016. This will total at least 1.1 trillion euros, which is approximately 1.3 trillion dollars.
I see this as the ECB trying to imitate the Federal Reserve. The Fed has quintupled the monetary base over the last 6 years, with its biggest round of monetary inflation coming to an end this past October. Yet much of this money went into bank reserves and consumer price inflation has stayed relatively low.
It is almost as if the Fed has had a free lunch. It has gotten away with its biggest round of monetary inflation ever with few consequences. Meanwhile, the U.S. economy is looking better, especially when you compare it to Japan or Western Europe.
It might almost seem rational for the ECB to try to imitate the Fed. Much of Western Europe is in recession or worse and the price inflation is low there as well.
Unfortunately for the Keynesian central bankers of Europe, things might not turn out the way they plan. Mario Draghi, central banker and former Goldman Sachs guy (or do I repeat myself?), may not get off as easy as central bank officials in the U.S.
First, it is important to point out that things have not played out in the U.S. yet. The economy is seemingly strong and much of it is because of the Fed’s inflation. But asset bubbles take some time to pop. The popping of the oil bubble may just be the beginning. Perhaps stocks are not far behind.
The point is, central bank inflation misallocates resources and it slows down productive growth. At some point, these misallocated resources get exposed and the realignment usually means a recession, unless it is not too severe and other areas with strong productivity are able to offset it.
The second problem for Europe and the ECB is that Europe is not the same as the United States. There is simply not as much real wealth. The U.S. is a very entrepreneurial society and there is a lot of wealth from 200 plus years of capital accumulation. Western Europe has been more of a hardcore welfare state and is relatively poorer in general.
When there is less in the way of real wealth and real savings, then things can’t be covered up as long. The people of Greece are finding this out the hard way right now.
When there is a large amount of government spending, coupled with central bank inflation, a wealthier society can withstand it better, at least for a period of time. There is more real wealth to sustain things.
It is no different than a family. If you have to take a pay cut and you are spending more than you are earning, you will be able to better withstand the situation if you have a lot of prior savings. In terms of a country, I am not talking about government savings. I am talking about real wealth that is owned by the individuals.
The ECB may find that its policies have almost no effect up front. Meanwhile, they will be misallocating resources and hurting long-term wealth production. It will wipe away what little savings are left there. If much of Europe finds itself in recession, maybe the ECB will up the ante and create even more inflation. But then it will just exacerbate the problem more and they may end up with a depressed economy and high price inflation at the same time.
Overall, it isn’t going to be pretty for Western Europe in the long run. The ECB is making things worse. It is wasting real capital and real wealth. If I were living in Western Europe right now, I would want to be in Switzerland, away from the euro.