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European QE is a bluff

The ECB is ready to look at quantitative easing. No time like five years too late, the Anglo-Saxon world might justifiably comment. But actually, for much of the eurozone, it’s still much too early. The ECB, tasked from this year with oversight of Europe’s banks, surely knows this, but that hasn’t stopped it using QE talk to frighten the markets into keeping long-end rates low.

But it is just talk. Five years into the QE experiment, the market, and the ECB, knows that it creates asset bubbles, that it doesn’t necessarily channel money into the real economy (or not into the right bits of it) and that it creates a cruel hangover once the punchbowl is removed.

The plus points, too, are not as clear as they once were. Persistent deflation is usually considered a problem for central banks, but in the eurozone, it is a feature, not a bug. When exchange rates are fixed, costs need to adjust instead.

Peripheral deflation is the intended consequence of structural adjustment programmes, not an unfortunate accident of insufficiently vigorous central banking. And it won’t be fixed by a QE that looks anything like what the Fed or Bank of England has done so far, because, as the ECB has abundantly acknowledged, Europe’s banks remain a lousy transmission mechanism to borrowers that do need credit.

Even if the ECB throws enough money at the fixed income market to push nominal yields down to Japanese levels, then so what? Frothy asset classes will boil over. Leverage, for borrowers that can get it, will increase. Credits will become less differentiated. But why any of this should boost real economy demand it is unclear.

In the absence of feasible action, talk is a decent alternative. Long term yields can be nudged down without drowning the market in liquidity.

That is why the ECB is sabre-rattling about buying securitization, but this, too, cannot work as a transmission mechanism in the short or medium term. It’s a way to improve European capital markets long term, by bringing in a broad range of participants, creating more competition (and maybe reducing the rent-seeking tendencies of the financial sector in the process), but it isn’t a way to fix monetary policy.

Draghi used his speech in Amsterdam last week to committ to enhanced transparency, and to remind markets (very transparently) that the Governing Council was unanimously committed to using unconventional measures to get eurozone inflation back up. But transparent talk is different to action. However much the ECB might talk about action, Europe is not in a place where any of the "conventional unconventional" measures used by the Fed or Bank of England can have much effect.

Moreover, the ECB almost certainly knows this. As it gets stuck into the asset quality review, supposed to be complete by the autumn, there is no institution better placed to understand the nastiness that still lurks on eurozone balance sheets, and the problems of relying on banks to push funds through to the real economy. To put it another way, UniCredit took a €14bn writedown last year. Even if the ECB can help improve profitabiltity in SME lending, that's equivalent to a lot of enhanced margins for a lot of years.

The only version of QE that might have a chance of acting on eurozone deflation is proper helicopter money — give out money to populations, cut out the financial markets entirely. The ECB cannot and should not do this through bank accounts, since that means forcing the banking sector to increase its short term liabilities, but fortunately, in the €500 note, it has the perfect instrument to hand out.

But unless the ECB has the stones for that, write off the QE hints as just talk.

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