The Eurozone January trade deficit has come in somewhat wider than expected at €10.5bn versus a downwardly revised gap of €1.7bn in December.
According to Howard Archer, Chief UK and European Economist at IHS Global Insight, those figures graphically show to what degree deteriorating domestic demand is outweighing the benefits of a weaker euro relative to its its July 2008 highs. Of course, with the euro strengthening, this is only likely to get worse.
As he explains (our emphasis):
Extremely weak global economic activity seems certain to continue to hit Eurozone exporters very hard over the coming months, thereby contributing significantly to the region’s ongoing serious economic problems. Sharply contracting domestic demand in the UK and the US, as well as substantially deteriorating activity in Emerging Europe, is particularly bad news for Eurozone exporters. Meanwhile, Eurozone exporters will be desperately hoping that the current spike up in the euro will not be sustained.
So what is the ECB likely to do about this? As FT Alphaville suggested last week quantitative easing could help the Euro-zone’s situation to a great degree.
But as Merrill Lynch’s Gilles Moëc points out in a recent report, real QE –however beneficial — could still be problematic for the ECB:
The Maastricht treaty specifically bars the ECB and the national central banks from purchasing government paper at issuance. However, they are allowed to purchase this asset class for “monetary policy purposes”, but in a way that should not “facilitate the financing of governments’ deficits”. This is a thin line. Another reason behind the ECB reluctance to purchase government bonds is the potential threat to its independence. For the time being, government debt benefit from the flight to quality. If financial markets normalize, governments will probably face a rise in the rates their pay on an inflated public debt. The political pressure on the ECB to continue to purchase government paper will probably be extreme.
That said, as Gilles also emphasises, there is a thin line in the interpretation of those rules. That means it’s not entirely impossible.
Accordingly, it is only the ECB’s inflexible nature and its general unwillingness that is stopping it from pursuing QE policy. Not that that should come as a surprise given the general bureaucratic nature of all things European Union-orientated. But there is another point to the story. Why would the ECB – however bureaucratic- not engage in a process like QE if it definitely could help the region? As former BoE MPC member Willem Buiter points out too – there really is nothing stopping it from doing so if it really wanted to. What’s more, its reluctance to do so sees it focusing on other means instead that could actually be doing much more harm than dodging QE alone. As he explains (our emphasis):
The ECB are fiddling while the Eurozone burns. Both the Bank of England and the Fed have started quantitative easing (QE, that is, purchases of longer-dated government securities financed by increasing the monetary base), albeit on a modest scale, especially in the US. Japan, which pioneered QE, is at it again. Switzerland has engaged in a special kind of quantitative easing, involving not the purchase of Swiss government securities but the purchase of foreign exchange reserves. Such non-sterilised foreign exchange market intervention is a form of QE which is targeted specifically at the exchange rate. Sweden is about to join the QE club. Canada may not be far behind.
No sign, however, of any QE or CE by the ECB. When challenged on this, the ECB points to what it is doing. In particular, it makes available unlimited credit at maturities from one week to six months – against eligible collateral – at the official policy rate, now 1.5 percent . This is good, but not good enough. The maturity for which such credit is extended should be extended to one year, 18 months and two years.
The ECB also has a very liberal definition of eligible collateral – effectively anything that does not move (and a few things that do) is eligible as collateral, as long as it originates from within the Eurozone, is euro-denominated and is rated at least BBB-. Indeed the Eurosystem has since the crisis started accepted increasing amounts of rubbish collateral, exposing it to serious private sector credit risk (default risk) on its collateralised lending and reverse operations. For reverse transactions and collateralised lending, default risk is the risk that both the borrowing bank will default and that the collateral offered by the bank will go into default.
The Eurosystem’s willingness to provided unlimited security at the official policy rate (OPR) of 1.5 percent has flooded the system with short-term liquidity to such an extent that the unsecured overnight interbank rate is now close to the ECB’s deposit rate of 0.5 percent (the deposit rate is the rate at which banks can deposit funds overnight with the Eurosystem). The difference between the effective overnight interbank rates in the Eurozone, the UK and the US is therefore much smaller than the difference between the OPRs (1.5 percent, 0.5 percent and 0 to 0.25 percent respectively).So why won’t they do it? In Buiter’s opinion it has more to do with memories of Weimar for some ECB members than anything else. There is also the issue of a ‘material risk of default’ on the debt of some Eurozone national governments disincentivising large-scale purchases of sovereign debt. Lastly there is also the general fiscal segregation of Europe. As Buiter puts it:
An entirely valid reason for the ECB/Eurosystem to refuse to engage in either outright purchases of private securities or in unsecured lending to the banking sector (or to the non-financial enterprise sector directly), is that there is no ‘fiscal Euro Area’, just as there is no fiscal EU. The absence of a fiscal Europe that matters here is a narrow one. I am not talking about the absence of a significant supranational fiscal authority in the EU (or in the Eurozone ), with significant tax, spending and borrowing powers -one capable of material system-wide fiscal stabilisation and cross-border redistribution. I am talking instead about two related fiscal vacua.
The first vacuum is that there is no single fiscal authority, facility or arrangement which can re-capitalise the ECB/Eurosystem when the Eurosystem makes capital losses that threaten its capacity to implement its price stability and financial stability mandates. The second related vacuum is that there is no single fiscal authority, facility or arrangement which can re-capitalise systemically important border-crossing financial institutions in the EU or the Euro Area, or provide them with other forms of financial support.Essentially his point being that Trichet cannot be expected to make 16 phone calls everytime the ECB develops an unsustainable hole in its balance sheet. In his eyes the situation is actually ‘intolerable’, with only one potential solution – fiscal unity:
We need a fiscal Europe, at least at the level of the Eurozone, to fill the first vacuum. If we are to fill the second vacuum, we need a fiscal Europe at the EU level also.
Of course, until the issue of QE is rectified, the euro will likely remain the laggard in the international currency devaluation race. Not good news for European exporters or the Eurozone trade deficit.
Related links:
QE and the ECB? – FT Alphaville
Does a single European bond hold the answer? – FT Alphaville