European Central Bank Chair Mario Draghi’s 2012 pronouncement of a trigger-happy “whatever it takes” monetary policy justified his nickname “Super Mario.” As president of the bank, or the ECB, he filed the only institutional chair with truly systemic or authority. From where he saw the situation, there was not a sum of national crises, but a single European challenge. And markets were relieved that it was still possible to cut through the member-state’s indecision and follow the United States in using the unconventional tools required to address the worst economic crisis the world economy has known.
This week, as the markets teeter on the precipice of yet another crisis, the ECB was decisive. The difference today is that the member states seem to be following through with their commitments Politically, no one is ready for a EuroCrisis 2.0 and the “whatever it takes” dogma is now being echoed by a chorus of players.
Make no mistake: the global economy is in trouble. Over the last week, the European Central Bank, the US Federal Reserve, and even Germany have recognised that there is a need to reverse course and reenergise the economy by boosting domestic demand.
The days of cheap liquidity are hardly over. Europe and the world at large need a boost in demand.
Stepping on a major break
Growth in the Eurozone fell to its lowest level in four years in the third quarter of 2018, with the region’s economy expanding by just 0.2%. Germany is entering its 10th consecutive year of uninterrupted growth. But earlier this month the government cut its 2019 growth forecast from 1.8% to 1%. That is a substantial deceleration compared to 1.5% growth in 2018 and 2.2% in 2017.
The question now is whether this is the end of the good times.
The second biggest economy in the Eurozone, France, appears to be outperforming Germany. In the last quarter of 2018, the French economy was growing at a respectable 0.3% growth, despite a global slowdown and the destructively violent Yellow Vest protests in Paris. Doing better than Germany, however, means little if unemployment hovers near 9%. French growth is export driven and is expected to reach 1.7% this year, but that compared poorly to the 2.3% achieved in 2017.
Italy’s statistical service (ISTAT) confirmed on January 31 that the third biggest economy in the Eurozone is in a recession after shrinking by 0.2% in the second quarter and 0.1% in the third quarter. Two consecutive quarters of negative growth is the official definition of a recession. More worryingly, the Italian unemployment rate has been surging again and has hit the double-digits.
Across the Atlantic the numbers have been looking worse as well. Overall, the US economy reached an annual pace of 3.5% growth in 2018, but most projections for 2019 point to growth below 2%.
With growth at “merely” 6.6% in 2018, the last quarter of 2018 was China’s worst in 40 years and the worse year since… well, you guessed it, 2009. For the first time in decades, China’s car dealerships and smartphone sales experienced a severe drop in demand.
Whatever it takes…everywhere
It is high time for the “whatever it takes” approach.
Throughout the first half of 2018, the US Federal Reserve and the European Central Bank were on course to end extraordinary asset-buying measures and begin hiking interest rates. Draghi, however, recognised that the Eurozone’s economy has been doing worse than expected and committed to retaining ultra-low interest rates throughout the summer of 2019.
And while the European Central Bank ended its asset-buying programme in December 2019, the effect will be cushioned. The ECB board will reinvest yields from maturing bonds issued during its four-year €2.6 trillion quantitative easing programme to refinance sovereign debt at least until the end of the year.
Draghi also said that the ECB could exchange its bond-buying programme if necessary.
The Chairman Powell of the US Federal Reserve also reversed course on Wednesday. Recognising the slowdown, he also went on to signal flexibility in the implementation of the US bond-buying programme. Powell had initially committed to shrinking the Fed’s $4.1 trillion balance sheet to $3 trillion. On January 30, Powell suggested this process would be much more gradual. Perhaps more significantly, Powell hinted at asset buying as the new normal as lenders deposit more assets to satisfy bigger cash reserve demands since the financial crisis.
As for the People’s Bank of China, it has cut bank reserve ratios five times since last year, allowing lenders to release more liquidity.
Boosting domestic demand
Faced with the politically scary prospect of a second recession, governments in Europe are not leaving everything to the ECB. China was a major factor for European and US recovery, generating a third of global growth and absorbing everything from Italian wine to American iPhones and German cars.
True, China has a trade surplus with everyone but Germany, but the world is addicted to its surging volumes of imports as much as it is addicted to cheap liquidity.
Chinese demand will not suffice now. The ongoing Sino-American trade war and the prospect of a disorderly Brexit forces Europe to look at its domestic market. In 2019, Germany’s export-driven current account surplus is expected to run at 7.3%, well above the EU commission’s recommended level of 6%. This imbalance is increasingly toxic and each of the big three Eurozone economies are investing in measures to boost domestic demand.
Germany’s economy minister Peter Altmaier called on January 31 for measures to stimulate the domestic economy that were, in a typical German fashion, productivity oriented. He talked about a new law to fast-track infrastructural development projects, tax incentives for corporate investment, and tax deductions for investment in energy efficiency for households and businesses. Still, this does amount to boosting domestic demand and the whole package would amount to €10 billion.
French President Emmanuel Macron promised an appeasement package to the Yellow Vest movement that is also worth €10 billion. It includes a €100 increase to the €1,499 minimum wage, the cancelation of a fuel tax, the cancelation of a tax on pensions below €2,000 a month, and tax-free overtime and end-of-year bonuses.
And Italy has set aside €10 billion for a new income support scheme known as the citizens wage – the lowering of the retirement age, and tax relief for the self-employed. It took several months, but Italy’s “radical budget” is now becoming the new normal.
This time Europe cannot export its way out of the crisis. While bankers do their job, politicians need to do theirs.