The remarkable reversal in the outlook for official interest rates over the past few months has received relatively little attention. Until recently it was widely accepted that rates could only move upwards. It looked almost certain that quantitative tightening (QT) would supplant quantitative easing (QE). Now the balance has reverted to further monetary accommodation.
If there was any doubt about this, it was dispelled by Mario Draghi, the president of the European Central Bank (ECB), in his speech last month at the annual ECB forum in Sintra, Portugal. Towards the end of his address he inserted a reference to the possibility of further QE.
If the risk outlook does not improve, and if price stability is threatened, he said “additional stimulus will be required”. Given the guarded character of speeches by central bankers this represents a strong statement.
Shortly after Draghi’s speech, a man not known for his reticence tweeted an angry response: “Mario Draghi just announced more stimulus could come, which immediately dropped the Euro against the Dollar, making it unfairly easier for them to compete against the USA.”
Despite his lack of diplomacy, the US president had a point. The prospect of further QE does weaken the euro which in turn bolsters the competitiveness of euro-zone exports into the US. That is independent of whether that was Draghi’s intention.
Of course, Donald Trump was indulging in special pleading rather than taking a principled stand against currency manipulation. His concern is getting a better deal for the US rather than countering an insidious form of protectionism.
Nevertheless, it provides yet another example of the dangers bought about by the protracted period of QE. As George Muzinich, the chairman of Muzinich & Co, says in this month’s Strategically Speaking (p64): “We are living in Disneyworld”. That is QE has created an artificial monetary environment that is causing considerable harm.
The most damaging effect of QE is that it simply prolongs the period of economic lethargy. It undermines the mechanism by which ‘zombie companies’ – those that have fulfilled a useful purpose – can go out of business. Instead they survive on cheap credit. That in turns makes it harder for new companies to emerge to take their place.
It also opens the way for an even bigger financial crisis in the future. If Europe’s economic problems are not resolved they will come back to haunt us. The costs of living in Disneyworld are likely to be high.