Tag Archives: euro

Should Europe Utilize Quantitative Easing?

Quantitative easing is a measure taken by a central bank purchasing government securities in order to increase an economy’s money supply and, therefore, lower interest rates.

Aside from Greece, every country in the Eurozone’s long-term interest rates have fallen from their January 2014 rates. Some countries’ rates have fallen almost 2 and three-quarters of a percent, the average fallen amount among Eurozone countries (excluding Greece) being 1.77%. As many countries’ interest rates approach zero, quantitative easing fails to be as effective or even possible.

Governing Council member of the European Central Bank Jens Weidmann announced Thursday that the ECB will not be taking part in any quantitative easing strategies in the immediate future. The ECB would consider quantitative easing to remedy recent declines in inflation rates. However, Weidmann explained that these levels indicate disinflationary trends rather than deflationary trends. He attributes recent disinflationary trends with the falling costs of energy, which are temporary.

This comes after ECB executive board member Peter Praet explained that the ECB had “an obligation to act” to ensure it meets its remit of near 2% annual inflation for the region, he said.” Praet does not believe that inflation is caused by fluctuating energy prices.

Stephen Williamson, Vice President of the St. Louis Fed, argues that quantitative easing not only does not help disinflationary trends, it is deflationary in nature. His argument is as follows:

“when the Fed engages in quantitative easing it acquires securities held by investors in exchange for dollars. Investors will only accept those dollars, according to Williamson, if they believe the dollars will rise in value. Which is to say, the operation of QE seems to imply deflation.”

Senior Editor for CNBC John Carney argues that term premiums have much more to do with it. Investors will accept these dollars if term premium—the added return of holding long-term bonds over cash—shrinks. He believes that quantitative easing leads to shrinking term premiums and therefore it is a self-starting cycle that does not cause deflation.

I think Europe should not engage in quantitative easing until the deflationary period that Weidmann discussed ends. The risk of acting too quickly and not allowing other effects to take place would be hasty. The ECB should wait and see what will happen with energy prices and the cost of oil. Also, the ECB should observe Greece’s recovery and see if the Greece’s government will stick to the measures that have been placed on them and how that will affect the broader economy.

Will Europe Finally Join the QE Bandwagon? (Revised)

Europe has struggled to rebound from the Great Recession.  A few years ago, it appeared that the EU and the United States were recovering at roughly the same pace, as shown by this graph of World Bank data on GDP growth rates.  In 2012, the EU dropped off of the path to recovery, posting a -0.4% growth rate, while the United States continued to chug on at around 2% growth per year.  This divergence was largely a product of the two different policy approaches taken by the central banks of each economy.  In the US, the Fed engaged in three separate rounds of large monthly bond purchases, or quantitative easing, with the goal of expanding the money supply and lowering interest rates.  In contrast, the European Central Bank responded with the European Financial Stability Facility to provide liquidity to EU members, and several European states undertook austerity policies.  It may be slightly naive to attribute all of the US economy’s recovery to QE, but it certainly appears to have been incredibly effective.

So why did the EU not even attempt QE while the Fed was rolling out several rounds of it?  One big obstacle that the ECB faces is the fact that it is composed of a multitude of national central banks, making it far more difficult to coordinate asset purchases.  However, it appears that the time may have finally come for the European Central Bank to enlist the help of QE.  As reported in the Wall Street Journal, the ECB’s executive board has proposed a 12-month (at minimum) round of QE, composed of asset purchases of €50 billion per month.  The bank’s governing body will meet Thursday to discuss the proposal.  As noted by MIT professor Athanasios Orphanides in the Journal article, “the potentially open-ended nature of the program—the idea the ECB could continue beyond a year—is a bright spot that could give the program additional power”, since many economists believe one of the core strengths of QE is the effect on the market that expectations of aggressive future monetary policy can have.  More specifically, a central bank indicating that it wishes to keep interest rates low will have far more credibility if it is engaging in QE, since it is exposing itself to the risk of losses on the assets it’s buying up if rates were to rise, as pointed out by an article in The Economist that gives a fantastic overview of the implications of QE.

As news of the potential ECB actions broke, the euro fell against the dollar – good news for the multitude of European states that rely heavily on exports to fuel their economy.  Italian prime minister Matteo Renzi was one of those who welcomed the news, who claimed that he dreams of parity between the Euro and the Dollar in an interview with the Wall Street Journal earlier today, believing that it would grant Europe greater economic flexibility.  However, it is not good news for everybody – German officials oppose the ECB plan, as noted in the first Journal article, since German taxpayers have concerns that they would be responsible for the more risky debt of other European countries.

Since I originally wrote this post, the official ECB press release has been issued, and thus some new pieces of information have emerged.  The official plan is more ambitious than what was originally proposed by the ECB exec board: the monthly purchases will be €60 billion each, and will continue through September 2016 at minimum, far longer than the original 12 months.  This would result in about a €1.1 ($1.24) trillion injection into the eurozone, making it about 75% the size of the Fed’s QE3 program (which was roughly $1.7 trillion), in a very similar format.  The Germans are likely to be pleased with the loss-sharing arrangement: only 20% of asset purchases will be subject to risk-sharing, which, in my opinion, is a necessary arrangement to ensure that every member of the monetary union is convinced.  It’s worth noting that the ECB is strictly targeting inflation with this policy, whereas the Fed’s primary goal with QE was to put downward pressure on interest rates.  It is this disparity in policy goals that leaves me with doubts about how effective QE will be for the eurozone: interest rates are already quite low, so the ECB stands to gain little ground in that respect.

Weakened Euro

The Euro has been depreciating relative to almost all other currencies for a while now. The euro used to be able to buy ~1.40 American Dollars, but now has fallen to just 1.11 US Dollars. This has caused mixed opinions on whether this is a good thing for the Eurozone currently. This depreciating of the currency will bring many benefits to the members of the Eurozone and help get their economy, which has been struggling the most out of all major developed countries following the Great Recession of 2008. This will be done by the influx of demand for now cheap European goods. Consumers from all over the world will flock to the Eurozone as goods produced there have become much cheaper. A simple example of why consumers will flock to European goods is: imagine that France produces widgets. France’s widget costs 100 euros. As late as one year ago, this widget would have cost an American $140. This is because to buy a widget, an American must first exchange his American dollars for European euros. The exchange rate was ~1 euro=1.4 U.S dollars. Today though this same consumer can purchase this widget for only $111. This will cause a lot more consumers to demand these widgets and able to afford them! As Tommy Stubbington wrote in his Wall Street Journal article, Parity Rumblings Emerge Over Euro, “”The euro area stands to be a winner of the currency wars in 2015,” said Jonathan Baltora, inflation linked bonds fund manager at AXA Investment Management, which oversees 607 billion euros of assets, referring to the possibility that a weaker currency would make European goods cheaper than those produced in Japan and elsewhere.” This is precisely what is going to happen, and what Europe NEEDS to happen to finally get out of this period of virtually no economic growth lately. The European Central Bank knows this and that is why (or atleast part of the reason why) the ECB announced a quantitative easing plan of bond buybacks. As Joseph Adinolfi writes in his article, Euro Records Largest Weekly Loss Since Septemeber 2011, “BK Asset Management’s Boris Schlossberg rhetorically asked if eurozone quantitative easing was intended to drive the euro even lower, arguing that ECB Executive Board member Bernard Coeure admitted as much during an appearance from Davos, Switzerland that was broadcast on CNBC Friday. “Taken from that perspective the ECBs actions make perfect sense,” Schlossberg said in a Friday morning research note. “The QE announcement has shaved another 300 points off the EUR/USD exchange rate and the pair is now fully 20% lower than just nine months ago.”” This will hopefully give the entire Eurozone the economic boost it needs to get back on track as an economic heavyweight!

Will Europe Finally Join the QE Bandwagon?

Europe has struggled to rebound from the Great Recession.  A few years ago, it appeared that the EU and the United States were recovering at roughly the same pace, as shown by this graph of World Bank data on GDP growth rates.  In 2012, the EU dropped off of the path to recovery, posting a -0.4% growth rate, while the United States continued to chug on at around 2% growth per year.  This divergence was largely a product of the two different policy approaches taken by the central banks of each economy.  In the US, the Fed engaged in three separate rounds of large monthly bond purchases, or quantitative easing, with the goal of expanding the money supply and lowering interest rates.  In contrast, the European Central Bank responded with the European Financial Stability Facility to provide liquidity to EU members, and several European states undertook austerity policies.  It may be slightly naive to attribute all of the US economy’s recovery to quantitative easing, but it certainly appears to have been incredibly effective.

So why did the EU not even attempt quantitative easing while the Fed was rolling out several rounds of it?  One big obstacle that the ECB faces is the fact that it is composed of a multitude of national central banks, making it more difficult to coordinate asset purchases.  However, it appears that the time may have finally come for the European Central Bank to enlist the help of quantitative easing.  As reported in the Wall Street Journal, the ECB’s executive board has proposed a 12-month (at minimum) round of QE, composed of asset purchases of 50 billion euros per month.  The bank’s governing body will meet Thursday to discuss the proposal.  As noted by MIT professor Athanasios Orphanides in the Journal article, “the potentially open-ended nature of the program—the idea the ECB could continue beyond a year—is a bright spot that could give the program additional power”, since many economists believe one of the core strengths of quantitative easing is the effect on the market that expectations of aggressive future monetary policy can have.

As news of the potential ECB actions broke, the euro fell against the dollar – good news for the multitude of European states that rely heavily on exports to fuel their economy.  Italian prime minister Matteo Renzi was one of those who welcomed the news, who claimed that he dreams of parity between the Euro and the Dollar in an interview with the Wall Street Journal earlier today, believing that it would grant Europe greater economic flexibility.  However, it is not good news for everybody – German officials oppose the ECB plan, as noted in the first Journal article, since German taxpayers have concerns that they would be responsible for the more risky debt of other European countries.  Nevertheless, it appears to be the case that the ECB will carry out quantitative easing, having tried almost everything else, in an attempt to resuscitate the stagnant European economy.

Unforeseen Decision by Switzerland’s Central Bank Shocks Currency Traders

Just a week ago, it looked as if Switzerland’s central bank, the SNB, was fully committed in the battle against the appreciation of the franc caused by a rush of foreign demand due to the ruble’s sharp decline.  As Miles Kimball wrote in Quartz, the bank had recently begun complementing its open market purchases with a negative interest rate on its holdings, and was willing to push interest rates even lower to protect their target exchange rate of 1 franc to .833 euros.  Consequently, global currency markets were shocked Thursday when the SNB announced their decision to renounce the euro exchange rate cap, per the Wall Street Journal, causing the franc to suddenly appreciate 30% against the Euro, and a sharp dip in Swiss equity prices.  The move makes it harder for the SNB to address its primary goals: minimize deflation and protect Swiss exports, which account for roughly 72% of the Swiss economy, according to Quartz.

The immediate effects of the central bank’s decision were felt by currency traders across the world, as reported by the Journal, who had placed numerous bets (many of them with high leverage) that the franc would depreciate against the Euro due to the SNB’s recent protective actions.  One foreign-exchange broker, FXCM Inc., suffered hundreds of millions in losses and was rescued Friday by an emergency loan.  As noted in the Journal, some hope that the heavy losses suffered by foreign-exchange traders will bring attention to the high leverage nature of the market, in which “Brokers allow traders to place bets of as much as 50 times their initial deposits in the U.S.”, and “In Europe and parts of Asia, leverage can reach 200 to 1, or higher.”  Even though we are now some six years past the recession, I would have hoped that global investors would be wary of such high leverage, after seeing the financial collapse brought about by novice homeowners with massive leverage on their mortgages.  It appears that some simply cannot resist the temptation – leverage of 200 to 1 makes me squirm with discomfort just thinking about it, though there are some bold souls out there still willing to assume such massive levels of risk.  Count me in amongst the writers of the Journal, as an individual who heartily supports the hope that massive losses like those suffered Friday will bring more attention to risky markets.

Looking forward, it appears the SNB “will continue to monitor the [foreign-exchange] situation and act as necessary”, per the Journal this morning.  The SNB’s president, Thomas Jordan, was quoted as saying that the franc was “greatly overvalued”, and he expects the bank’s negative interest rate policy to be its main tool for reducing foreign demand for the franc.

SNB Decision and Economic Ramifications

The Swiss National Bank (SNB) shocked the entire world with its decision to remove their peg holding the Swiss franc at 1.20 euro’s. This move caused turmoil in all FX markets as well as across the world. The biggest ramifications of this shakeup will be felt in Switzerland (obviously). This was deemed necessary because the Swiss franc had surged in value. This move to remove the currency peg will affect retailers of Switzerland products because their goods now look more expensive. Since there products are now considered more expensive, Swiss retailers will find it harder to sell their products, and even harder to export them. As chief executive of Swatch Group, a luxury Swiss made watch corporation, said in the Economist article, Shaken, not Stirred, “The bank’s action was “a tsunami” for exporters, tourism, and “the entire country.”” This same article later says, “Luckily I was sitting down” when the SNB called to warn of its impending announcement, said Johann Schneider-Ammann, the federal economics minister charged with trying to keep the Swiss industry competitive. Exporters, he acknowledged, face a huge challenge.” As you can see from the chart pictured below, the euro has collapsed in Swiss franc terms. Meaning that one euro used to buy 1.2 Swiss francs, but now that same euro only will get you ~1 Swiss francs. This makes everything in Switzerland ~20% more expensive for foreigners. This has impacts that will be felt throughout the entire Swiss economy, including retailers, restaurants, hotels, tourism, and consumer goods.

Screen Shot 2015-01-23 at 1.01.21 PM 

This impact was immediately felt as Swiss companies lost upwards of 10% of their share price as soon as the news hit. This was felt extra hard by Swatch, who has lost 18% since the SNB announcement. In response to this, as John Revill writes in his article, Watchmaker Swatch Announces Price Rises, “Swatch, based in Biel, said it would increase the prices charged outside of Switzerland for some of its brands by 5% to 10%. The move comes as the franc has gained more than 15% in value versus the euro following the Swiss central bank’s decision last week to scrap a long-standing currency cap.” This move is to try and offset the loss of future sales that they are no doubt going to see. This move will certainly hurt Swatch’s (and every other Swiss based company’s) bottom line (which caused the respective stocks to drop), but at least there are no more surprises coming… We hope!