Promises – but what can banks do?

Sunday 12 August 2012

SINCE the President of the European Central Bank, Mario Draghi, said two weeks ago that the bank will do "whatever it takes" to save the euro, the markets have been gearing up for more quantitative easing.

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By Callum D’Ath

While the US has since 2008 conducted QE1 and QE2, and the UK has been conducting "ongoing QE", the European bank has so far resisted. This is because full quantitative easing in Europe needs a treaty change, as there is a German ban on monetisation of government debt by the ECB.

Alas, Draghi disappointed markets somewhat by not unveiling QE or something similar last week. He did, however, hint strongly at more to come. The likely quid pro quo will be that Europe, led by France, signs up to the fiscal compact, and Spain and Italy get their fiscal house in order. Governor Sir Mervyn King's comments this week that the Bank of England will "do all it can" to bring about the recovery seems to echo Draghi's observations on the euro. The only problem is that no-one is very clear on what these statements mean. Standing back from the will they, won't they debate, what about the efficacy of quantitative easing? It can be argued QE1 in the US and QE in the UK prevented depression and financial collapse in 2008. However, QE2 in the US forced up the prices of commodities such oil, with a negative impact on the economy. In the UK it could be argued QE has not had much impact since the first round and has less impact each time. An economy that has contracted for the last three quarters is not indicative of a successful policy, although King may argue the economy would otherwise have been even worse.The Bank for International Settlements (BIS) highlights in its recent annual report that every time central banks expand their balance sheets – by lending money to impaired European banks or printing money and buying bonds under QE – the risks to the global economy rise. The risks include high inflation, prolonging deleveraging, since the incentive to pay down debt is taken away, and ultimately a lack of confidence by investors in the fiat money system of the US, UK and Europe. According to the BIS, central bank assets as a percentage of GDP for advanced economies have doubled since 2007 from 12% to 25% . As long as the Western world continues to go through a slow process of deleveraging coupled with slow growth, and Europe slowly moves towards fiscal integration, the likelihood is that central bank assets as a percentage of GDP will keep rising. Callum D'Ath is divisional director with private client investment manager Brewin Dolphin

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Promises – but what can banks do?

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