The European Central Bank announced a tapering of the repurchase program on September the 9th.
One would imagine that this is a sensible idea given the recent rise in inflation in the eurozone to the highest level in a decade and the allegedly strong recovery of the economy. However, there is a big problem. The announcement is not really tapering, but simply adjusting to a lower net supply of bonds from sovereign issuers. In fact, considering the pace announced by the central bank, the ECB will continue to purchase 100% of all net issuance from sovereigns.
There are several problems in this strategy. The first one is that the ECB is unwillingly acknowledging that there is no real secondary market demand for eurozone countries’ sovereign debt at these yields. One would have to think of twice or three times the current yield for investors to accept many eurozone bonds if the ECB does not repurchase them. This is obviously a dangerous bubble.
The second problem is that the ECB acknowledges that monetary policy has gone from being a tool to help implement structural reforms to a tool to avoid them. Even with the strong GDP bounce that the ECB predicts, few governments are willing to reduce spending and curb deficits in a meaningful way. The ECB estimates show that after the massive deficit spending of 2020, eurozone government spending will rise again by 3.4% in 2021 only to fall modestly by 1.2% in 2022. This means that eurozone government spending will consolidate the covid pandemic increase with little improvement in the fiscal position of most countries. Indeed, countries like Spain and Italy have increased the structural deficit.
The third problem is that negative rates and high liquidity injections combined with elevated government spending have generated no real multiplier effect in the eurozone. We must remember that the main economies were in stagnation already in the fourth quarter of 2019, before the pandemic and despite large stimulus plans like the Juncker Plan, which mobilized hundreds of billions of euros in investments.
The fourth challenge for the ECB is that it acknowledges being trapped by its own policy, it cannot stop it and normalize because governments and markets would suffer, and it cannot keep the current pace because inflation is putting even more pressure on growth.
The final challenge for the eurozone and the ECB is that they continue to implement policies that ignore demographics and structural burdens to growth. The eurozone has an aging population and monetary and fiscal policies seem to ignore the evidence of changing consumption patterns when citizens reach a certain age or retire. If we add to demographics a taxation system that increasingly hurts middle classes, businesses, and investment, we face an economy that seems to be following all the wrong policies that Japan implemented at the beginning of the 90s.
As Japan did, the eurozone is betting all on government spending, chains of stimulus packages driven by political directions, and massive debt monetization. However, the eurozone does not have the disciplined labor force that Japan has nor the elevated levels of corporate and household savings that allow the country to continue in stagnation for decades.
Countries like Italy, Spain, Portugal, or Greece cannot survive stagnation due to elevated levels of unemployment and the small size of the business fabric. Therefore, the ECB seems to ignore the risks of perpetuating the perverse incentives to bloat government spending and debt. All messages concerning structural reforms and real growth initiatives have disappeared in favor of directed stimulus plans that never deliver. Our duty as economists is to warn of the more than likely scenario of poor recovery, low productivity, and high debt that the eurozone faces. Fiscal multipliers have been negative for too long for us to ignore the negative crowding-out effect of high government spending and the erosion of competitiveness that the economy faces.
Daniel Lacalle is one the most influential economists in the world. He is Chief Economist at Tressis SV, Fund Manager at Adriza International Opportunities, Member of the advisory board of the Rafael del Pino foundation, Commissioner of the Community of Madrid in London, President of Instituto Mises Hispano and Professor at IE Business School, London School of Economics, IEB and UNED. Mr. Lacalle has presented and given keynote speeches at the most prestigious forums globally including the Federal Reserve in Houston, the Heritage Foundation in Washington, London School of Economics, Funds Society Forum in Miami, World Economic Forum, Forecast Summit in Peru, Mining Show in Dubai, Our Crowd in Jerusalem, Nordea Investor Summit in Oslo, and many others. Mr Lacalle has more than 24 years of experience in the energy and finance sectors, including experience in North Africa, Latin America and the Middle East. He is currently a fund manager overseeing equities, bonds and commodities. He was voted Top 3 Generalist and Number 1 Pan-European Buyside Individual in Oil & Gas in Thomson Reuters’ Extel Survey in 2011, the leading survey among companies and financial institutions. He is also author of the best-selling books: “Life In The Financial Markets” (Wiley, 2014), translated to Portuguese and Spanish ; “The Energy World Is Flat” (Wiley, 2014, with Diego Parrilla), translated to Portuguese and Chinese ; “Escape from the Central Bank Trap” (2017, BEP), translated to Spanish. Mr Lacalle also contributes at CNBC, World Economic Forum, Epoch Times, Mises Institute, Hedgeye, Zero Hedge, Focus Economics, Seeking Alpha, El Español, The Commentator, and The Wall Street Journal. He holds a PhD in Economics, CIIA financial analyst title, with a post graduate degree in IESE and a master’s degree in economic investigation (UCV).