by Nomi Prins
THE GREEK CONDITION
Greece continued to be the major problem in Europe. On June 5, 2013, Lagarde said the country should be in a position to pay off its debts while admitting that the IMF had failed to foresee the damage austerity imposed upon Greece.15
The IMF had released an internal report that documented how it had underestimated the damage of austerity. It confirmed what Greek officials had long said: that the first bailout of 110 billion euro in emergency funds in May 2010 in exchange for major budget cuts was the wrong prescription for a country battling a “monumental debt load,” “rampant tax evasion,” and a “flourishing black economy.”16
The IMF did not advocate reducing austerity measures, however. By 2013, Greece’s debt-to-GDP ratio had risen to 149 percent. All of its debt burden was incurred after the financial crisis, and yet the euro elite blamed Greece and not the speculators who had ransacked the country and headed for the hills during the crisis.
By now, Germany’s fear of European inflation had been replaced by the reality of deflation. Since April, the monthly consumer price index data for the Eurozone had failed to reach the ECB inflation target of 2 percent.17 The results gave Draghi incentive to opt for loosening monetary policy even more. He recognized the governing council was divided on the issue, but he remained undaunted. He would “decide about further action on the front of interest rates or, as I said before, on any other instrument that is available.”
An IMF report released in June 2013 noted that the growth assumptions for Greece had been too high and that the handling of the first international bailout had been a mistake. This left the Germans disgruntled yet feeling vindicated for having criticized the bailout structure.18
European instability notwithstanding, on June 19, Bernanke proclaimed the US economy was responding positively to his policies. He promised, “If the subsequent data remain broadly aligned with our current expectations for the economy… we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.”19 He was potentially putting the brakes on buying, not holding, assets.
Bernanke explained that removing stimulus was out of the question for the moment, though, and that even eventual rate hikes would be gradual. Kansas City Fed president Esther George expressed concern about the consequences expansionary policy would have on financial stability. St. Louis Fed chief James Bullard also dissented, arguing that the Fed should have made more clear its willingness to keep the stimulus to reach the 2 percent goal for inflation.
Minneapolis Fed president Narayana Kocherlakota said that the Fed did not provide clear guidelines regarding rates. He wanted the Fed to target a 5.5 percent unemployment rate and stop easing when it got there. The Fed wasn’t operating under an old paradigm of guidelines, though.
If the Fed, in a single unified country had problems, the EU, organizing various cultures and economic environments, was skating on far thinner ice. On July 17, Greece’s parliament approved another set of unpopular austerity measures, including a plan to put twenty-five thousand public employees on notice for possible dismissal as a condition of the latest EU-IMF bailout. That opened the way for a fresh tranche of funds worth nearly €7 billion (US$9 billion), pushing Greece’s bailout total to €240 billion (US$314 billion).20 Labor unions had called a general strike in protest the day before.21 Though Greece was the epicenter of crisis, economic contagion was spreading. By August 2013, Italy’s GDP had dropped eight quarters running.22
Non-US central banks began solidifying outside alliances. On October 10, 2013, the ECB and the PBOC established a bilateral currency swap agreement to buy and sell yuan and euro from each other.23 Valid for three years, it would reach RMB 350 billion for the ECB and €45 billion for the PBOC. The ECB announced this step, one of several in the growing number of bilateral trade and investment alliances between the Eurozone and China. This action had two goals: stabilizing financial markets and diversifying against the United States dollar and Fed.
The EU was China’s biggest export market: Europe and China traded roughly €480 billion in goods and services each year. Even if the move was not an earthquake, it was a significant tremor. And it was directed at the Fed. In June 2013, China had signed a similar agreement with the Bank of England, worth up to RMB 200 billion in swaps.24 These moves were signs the Fed had burned both central banks and that they sought relief from further risks by augmenting their associations with each other.
Draghi declared banks viable but in need of state aid to expand their capital base. As he highlighted on October 2, “The ECB wants to have full responsibility for the assessment, but nothing to do with what has to be done following the assessment, namely the task of the resolution authority.”25 Those were just words. The ECB was still heavily involved in keeping banks liquid, as would be obvious by the end of that month.
On October 31, the Bank of Canada, BOE, BOJ, ECB, Fed, and the Swiss National Bank announced that their temporary bilateral liquidity swap arrangements would become permanent—indefinitely.26 It was the era of conjured money.
For regular people, there was no such relief. The average member of the working class wouldn’t be able to readily identify a liquidity swap arrangement because that type of complexity was reserved for the financial elite, and even if they did know, they couldn’t access the same privileges central banks afforded to private banks.
A report from the International Federation of Red Cross and Red Crescent Societies warned, “The long-term consequences of this crisis have yet to surface. The problems caused will be felt for decades even if the economy turns for the better in the near future.… We wonder if we as a continent really understand what has hit us.” The report went on to say, “As the economic crisis has planted its roots, millions of Europeans live with insecurity, uncertain about what the future holds.… We see quiet desperation spreading among Europeans, resulting in depression, resignation and loss of hope.”27
At that point in time, there were twenty-six million people unemployed in the EU, with eleven million of them out of work for more than a year. The figure was more than double what it had been in 2008.28 According to a Red Cross Survey on Europe, “The amount of people depending on Red Cross food distributions in 22 of the surveyed countries has increased by 75% between 2009 and 2012.” The survey concluded, “More people are getting poor, the poor are getting poorer.”29
The first week in November, at a press conference at ECB headquarters, Draghi announced a 25-basis-point cut of the main refinancing operations rate to 0.25 percent and the marginal lending facility rate to 0.75 percent. The deposit facility remained at 0 percent.30 Eurozone inflation had fallen to 0.7 percent in October, since the May cut, after falling to 1.2 percent in April. A quarter of the council members, led by Bundesbank chief Jens Weidmann, were against the cuts.31 Dissention was building at the ECB as it was at the Fed, but that fracturing would meet the same roadblocks. Even if fabricated money wasn’t achieving its stated purpose of real economic growth, taking it away would invoke chaos on the financial system. That was a possibility that central bank leaders did not want to risk, not on their watch.
By early December 2013, the yuan had overtaken the euro as the second-most-used currency in international trade and finance after the dollar.32 It represented an 8.66 percent share of letters of credit and collections, compared to 6.64 percent for the euro. The dollar dropped to an 81.08 percent share versus 84.96 percent in 2012. Previously, in January 2012, the yuan had been the fourth-most-used currency, with 1.89 percent of the share; the euro had been second, with 7.87 percent. This shift was a major step toward balancing out the dollar’s power.
By the end of December, the euro reached its strongest level against the dollar in more than two years.33 Not only was the Chinese yuan charging ahead but the euro was making equal strides. The dollar, seen as a risky currency following the financial crisis, stabilized only because of its prevalence as the world’s dominant reserve currency. Div
ersification away from the dollar meant greater security for the future.
DIVERGENT CHEAP-MONEY POLICIES
On January 9, 2014, Draghi said the Eurozone might need further support to prevent a period of stagnation as Japan had experienced decades ago.34 He noted that high unemployment, the fall of inflation, and difficult lending conditions pressured the ECB to use all tools available to maintain confidence and growth. He vowed, “The governing council strongly emphasizes that it will maintain an accommodative stance of monetary policy for as long as necessary.”35
However, he also claimed confidence was gradually returning to the Eurozone and that his monetary policy was affecting the real economy, though not fully. “It’s fragile,” he said, “there are several risks, from financial to economic to geopolitical to political risks, that could undermine easily this recovery.”36
Draghi took his cues from the Bernanke school of taking credit for economic success even if it was tenuous at best. The two went way back together in education and ideology. Bernanke received his PhD in economics from MIT in 1979, just two years after Draghi earned his at the same institution. Both had the former vice chair of the Fed, Stanley Fischer, as their adviser. Bernanke later called Fischer one of the most influential figures in his life and economic outlook. CNBC referred to him as the “man who taught the biggest central bankers.”
Fischer also taught Larry Summers, Christina Romer, and Greg Mankiw and was an economic adviser to George W. Bush. MIT often houses professors who believe in the Keynesian economic teachings and subscribe to the belief that government intervention can aid economies. Fischer was number two at the IMF during the 1997–1998 crisis that stretched across the emerging markets financial system (Asia, Latin America, Russia). But conjuring money was different from Keynesian theories on government spending aiding the real economy. Big banks had no reason or requirements to care about how the real economy might operate. Speculative activities were faster, often more lucrative, and involved less effort to execute.
On June 2, 2014, Janet Yellen reinforced the status quo in the United States: “I do not presently see a need for monetary policy to deviate from a primary focus on attaining price stability and maximum employment.” She brushed aside bubble formations: “Because a resilient financial system can withstand unexpected developments, identification of bubbles is less critical.”37
Three days later, the ECB became the first G7 central bank to let rates go negative, as it slashed its deposit rate to –0.10 percent.38 As the ECB said: “In June 2014, following in the footsteps of the Danish National Bank, the European Central Bank (ECB) became the first major central bank to lower one of its key policy rates to negative territory.”39
In tandem, Draghi announced another package of easing measures too, confirming, “If required, we will act swiftly with further monetary policy easing. The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate should it become necessary to further address risks of too prolonged a period of low inflation.”40 Inflation, and whether it was low or high, was a convenient devil to be banished at all costs, even if you couldn’t see it.
Unlike prior measures, this one did not invoke the same adrenalin-shot response from the markets. Perhaps there was a limit to central bank stimulation effectiveness—on the markets, anyway. But that didn’t stop Draghi. He had a choice between dogmatic allegiance to conjured-money policy or the possibility of impacting society with that money. He chose the former.41
Draghi’s latest policy tool would provide more than €700 billion of cheap funding to banks. The ECB had identified loans to companies and households as key areas of weakness on the books of banks. Because of that, its long-term refinancing operation (LTRO) offered up to four years of low-cost funding tied to this kind of bank lending. According to Draghi, the measure “should ease their financing costs, allowing banks to pass on such attractive conditions to their customers.”42 The idea of trickle-down monetary policy, though not evident in practice, remained prominent in rhetoric.
On June 11, the ECB set its deposit facility interest rate below zero percent, meaning it would cost banks a fraction of a point to keep their money with the ECB. The idea was this would cause banks to loosen their purse strings and lend rather than sit on the massive amounts of cheap money available to them. In practice, banks preferred paying that negligible interest amount to the ECB so as to keep doing what they wanted with their money.
As a result, Draghi’s disputes with Germany intensified. Critics doubted the efficacy of QE. The euro’s rapid rise affected the ECB’s plans to influence the economy. In theory, the euro should have been contained by low rates and bond purchase programs. Draghi was still focused on what he referred to as “the danger zone” and on addressing inflation in the region.43 His bigger fear was that prices would fall into a deflationary spiral. He reasoned that negative rates would be a way to keep that from happening. He believed conjured money could inspire growth—a strange notion given that years of zero interest rate policy had produced minimal results.44
Even the BIS worried that Draghi’s blank-check-writing style was causing debt bubbles galore. As public debt blossomed, a chunk of it was subsumed by the ECB in its various QE programs, leaving room for more to be created. On June 29, Jaime Caruana, general manager of the BIS, said, “Rising public debt cannot shore up confidence. Nor can a prolonged extension of ultra-low interest rates. Low rates can certainly increase risk-taking, but it is not evident that this will turn into productive investment.”
He added, “If they persist too long, ultra-low rates could validate and entrench a highly undesirable type of equilibrium—one of high debt, low interest rates and anemic growth.” The BIS board of directors at the time included Janet Yellen and Mario Draghi.45 Neither of those conjurers appeared as worried as the central bank of central banks did.
The IMF reaffirmed its concern that the Eurozone faced “a risk of stagnation, which could result from persistently depressed domestic demand due to deleveraging, insufficient policy action, and stalled structural reforms.” Yet it prescribed more QE to soak up the government debt: “If inflation remains too low, consideration could be given to a large-scale asset purchase program, primarily of sovereign assets.”46 This raised the question of why it was necessary for central banks to purchase government debt. Rather than providing artificial demand for debt, they could have explored methods to divert that debt to real, tangible growth projects. That simply wasn’t a question that the central bank leaders, who were buying trillions of dollars in debt, asked.
On September 4, the ECB dropped its refinancing and lending facility rates by another 10 basis points and dropped the deposit facility rate to –0.2 percent. Yet another wrinkle in the QE plot appeared: the purchase of nonfinancial private-sector assets. Draghi noted these decisions were not unanimous, as they once had been, but “on the scale of the dissent, I could say that there was a comfortable majority in favor of doing the program.”47 He was a man with unlimited power to create money and was not afraid to use it.
The strategy still didn’t provide enough money for the financial system. So, as European stagnation remained critical, the G20 agreed to add an extra $2 trillion to the global economy to create millions of new jobs.48 Finance ministers and central bank chiefs had convened in Cairns, Australia, where they claimed to be making progress on protecting the world’s financial system—yet still needed to dump more money into it.
There, US Treasury secretary Jack Lew stressed philosophical differences and concern with some of his counterparts in Europe regarding stimulus: “If the efforts to boost demand are deferred for too long, there’s a risk that the headwinds get stronger and what Europe needs is some more tailwinds in the economy.”49 At the time, Lew had been at his post for barely a year. Previously, he had occupied an executive role in Citigroup’s alternative investments division, which had contributed to Citigroup’s implosion in 2007, and had been a member of the management co
mmittee there.50
His opinion, steeped in Fed policy, contrasted vastly with that of Wolfgang Schäuble and of Jens Weidmann, the Bundesbank chief, who emphasized the importance of strict budget controls and criticized the ECB and its policies of cuts in borrowing costs. “In my view,” Weidmann said, “the recent decisions by the ECB council [are] a fundamental change of course and a drastic change for the ECB’s monetary policy.” Further, “No matter how you think about the content of the decisions, the majority of the ECB council members are signaling with it that monetary policy is ready to go very far and to enter new territory.”51
However, Draghi maintained that his asset purchase plans could revive the Eurozone—if only they could grow in scale.52 “We stand ready to use additional unconventional instruments within our mandate, and alter the size and/or the composition of our unconventional interventions should it become necessary.”53
Draghi struggled to convince European banks to take more ECB cash to finance their lending. In contrast to other major central banks, the ECB had seen its assets shrink by a third since 2012. That’s why Draghi put the option of increasing QE purchases back on the table. There were two main explanations for banks not wanting more ECB money. First, they simply didn’t want to lend, one of their primary jobs relative to the public. Second, they had enough cash, and so denying their need for more allowed them to project confidence and strength. The latter reason translates to higher share prices and executive bonuses predicated on those shares.
On October 1, 2014, US Treasury yields versus their German counterparts leapt to their highest spreads since 1999, meaning global speculators were buying the notion that the Fed would tighten, which pushed bond prices down and yields up relative to the easy-money train of the ECB in the EU.54 Five days later, the minutes of the FOMC meeting expressed concerns that a rate hike in the United States could negatively affect global markets.55 One moment, it seemed monetary policy collusion could be nearing its end. The next, the conjurers realized that to truly do so would be to wreak global havoc and admit that it all had been a facade.