The ECB to Reduce Its Rate of Monetary Inflation

The European Central Bank (ECB) announced on Thursday that it would extend its own version of quantitative easing through the end of 2017.  The ECB was previously scheduled to buy assets (create money out of thin air) through March 2017.

After March, the ECB will reduce its rate of purchases from 80 billion euros per month to “just” 60 billion euros per month.  The euro has not reached parity with the U.S. dollar yet, so in terms of dollars, the net purchases will still exceed $60 billion per month using today’s conversion.

Mario Draghi, the president of the ECB, stated: “There is no question about tapering.  Tapering has not been discussed today.”

This is just a matter of semantics.  The term tapering was used in 2013 and 2014 when the Fed gradually reduced its rate of monthly monetary inflation.  QE3 eventually ended in October 2014 under Janet Yellen, but there was a lot of concern, at least in the financial media, about the possible effects of the taper.

The ECB was quick to say that it could further extend its buying program or ramp things back up if economic conditions warrant it.  In other words, inflation is always on the table as an option.

The level of buying is still massive by modern Western standards.  The Fed seemed to get away with it from 2008 to 2014, as much of the newly created digital money went into excess reserves at the banks.  The lack of lending helped keep consumer price inflation in check.  Perhaps the ECB figures the Fed got away with its massive monetary inflation, so it can do the same.

But the Fed has had a tight policy for 2 years now, despite having a low target for the federal funds rate.  It has not significantly hurt the Fed yet.  The Fed’s monetary inflation for 6 years, coupled with its policy of low interest rates, did its damage.  But it has been somewhat concealed because of the relatively low consumer price inflation.

Still, resources have been misallocated, and it has helped Congress spend more money than it otherwise would have.  We have not felt the full effects yet from the previous monetary inflation.  There are a lot of distortions in the economy, including in stocks.

Western Europe is an even bigger disaster than the United States.  It is a deeper welfare state.  The ECB’s purchases of debt includes negative yielding bonds.  The Fed never went this far.  There is going to be a bigger economic disaster in Europe than in the U.S., but we shouldn’t minimize the potential of major problems in the U.S.

As of this writing, the euro trades at around $1.06.  We should expect parity in the somewhat near future.  I think it will come in 2017.

The U.S. dollar is the least bad currency right now.  The Fed is not inflating, and the dollar is still the world’s reserve currency.  The yen has recently weakened against the dollar as well.  The euro and the yen are the only other major players on the open currency exchange markets.

The global economy really is a ticking time bomb.  Europe, Japan, and China are all worse off than the United States, but that isn’t saying that much at this point.

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