The ECB and Quantitative Easing A debt monetisation experiment?

One of the features of these times is how apparently unrelated events can in fact be linked. This happened yesterday when the President of the European Central Bank (ECB) Mario Draghi gave a speech to welcome the new 20 Euro banknote. Amidst the glad handing and his signature I spotted this.

In total, there are now 17.5 billion euro banknotes in circulation; the total value of these banknotes reached €1,000 billion for the first time in December 2014.

This confession of actual money printing raised a wry smile as I read it! Of course there are many accusations of money printing these days but here is the genuine article. There was also not a little hype and indeed fantasy.

Euro banknotes touch the lives of every one of us. As such, they bring us all closer together. As you saw in the video highlighting the new security features, the inclusion of the mythological figure Europa, who gave her name to our continent, shows how Europe draws on its shared history.

What about Quantitative Easing?

There is also a link in the amounts here as we compare one trillion Euros of banknotes with a planned 1.14 trillion Euros of ECB Quantitative Easing or QE. These days such a difference feels like a mere bagatelle although of course it is a lot of money. Somewhere along our journey we have become desensitized to large numbers. However let us begin to look at the effect it is already having.

Financial Markets

Bond Yields

Today’s headlines are being made by Ireland and the cause is the fact that it was spotted that Tradeweb had its ten-year yield closing at 1.01% last night. From Bloomberg.

Ireland‘s 10 year yield under 1% for the first time. Now twelve European countries with sub 1% 10 year yields.

If we look at the situation of Ireland this is extraordinary for two main reasons. Firstly it was not so long ago that the same bond yield was over 12%. This poses a problem as if you use market prices to value things as I often do you sometimes have to face up to the fact that the 12%+ of 2011 and the less than 1% of 2015 cannot both be right! Yes Ireland’s circumstances have changed for the better but not on that scale. Indeed it is the economic improvement which does not go with such a bond yield as we would expect them to be rising and prices falling in response to higher economic growth. As of the latest data the Irish economy is expanding at an annual rate of 3.4% (GDP) or 2.5% (GNP). The outlook is also apparently bright.

The latest Investec Manufacturing PMI Ireland report shows that further growth was recorded in the Irish manufacturing sector at the start of 2015 as client demand continued to improve.

Now the #PMI numbers have been far from infallible in Ireland but we are in a Houston We Have A Problem moment for Irish bond yields. In another odd coincidence this is as about as likely as a batsman being bowled but the bails rising and then returning to their grooves on the stumps! Arise Ed Joyce for those who do not follow cricket.

The problem is the economic effect of this in the real economy. We are in danger of what Charles Goodhart warned about some time ago.

Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.

In plainer English this has been refined into this.

When a measure becomes a target, it ceases to be a good measure

If we look at the possible effect on the real economy of all this then there is of course a probable effect on the housing market via lower fixed-rate and maybe variable rate mortgage costs. A surge in Irish house prices! What could go wrong?

From the Central Statistics Office

In the year to December, residential property prices at a national level, increased by 16.3%.

Portugal and Italy

Let me open this part of the discussion by pointing out that I think that both of these countries face a likelihood of some form of default before this saga ends. actually that makes me wonder if QE is an implicit default but let us park that for now and move on. The fundamental issue is that neither of these countries have managed any sort of sustained growth in the Euro era and have rumbled on in the “good years” at about 1% per annum. Indeed on a per capita basis the Italian economy has shrunk in the Euro era. As of the latest Eurostat data (Q3 2014) both countries had a national debt to GDP ratio of above 131% and rising. The statistical improvements such as ESA 10 have been deployed.

Yet we find that Portugal has a record low ten-year yield of 2.08% this morning and Italy one of 1.45%. These compare to somewhere in the high teens and over 7% respectively before the “everything it takes (to save the Euro)” speech by Mario Draghi in the summer of 2012.

By comparison the UK Gilt ten-year yield is 1.7% this morning as prices rally after Janet Yellen backtracked somewhat on US interest-rate increases (no surprise here). But I note that a country likely to default has higher price bonds and maybe soon Portugal will too!

In the future will all Euro area bonds be just like German bunds?

Or convergence trades mark two. How does that combine with this (h/t @MineForNothing )


Equity Markets

Whilst there are obvious individual issues such as the Greek equity market the overall picture was described this morning by the Financial Times.

in Europe the FTSE Eurofirst 300 is opening flat at its seven-year peak

Now that Europe has joined this particular party we are also seeing this.

All this leaves the FTSE All-World index, a worldwide gauge covering more than 3,000 large and mid-cap companies, up 0.2 per cent to 286.0 and on course to close the day at its best ever level.

The All-World has risen more than 150 per cent since its financial crisis low of March 2009.

So congratulations to everybody who is holding some equities as with some minor exceptions (I mean on a world scale not that they are themselves unimportant) you have been seeing a good run. Let me add in the fact that bond investors have done well too and we are verging on yesterday’s discussion about in equality are we not?!

Exchange Rates

In the financial world these are the main players in monetary policy in my opinion. Here the hints and promises of a “Bazooka” (surely that should be Panzerfaust?) of QE saw the effective exchange-rate drop from 100.6 in mid-December to just below 93 on the 23rd of January. Since then it has moved to around 94. This fits with my theory that the exchange rate effects of QE happen early and often precede it happening – so much for the cause and effect so beloved of the Frenchman in the film Matrix revolutions!- but of course we await the next move.


This turns on the impact of these moves on the real economy so let me address them in terms of likely size. The 7% fall in the Euro exchange-rate may give a boost but in an unfortunate accident of timing it occurred as the oil price and other commodity prices were falling as well and offset some of it. As the Fun Boy Three and Bananarama put it.

It ain’t what you do it’s the way that you do it
It ain’t what you do it’s the way that you do it
It ain’t what you do it’s the way that you do it
And that’s what gets results

If we move to the rising bond prices and falling yields they could easily fire up some of the Euro areas housing markets and in Ireland this is probably already in play. What could go wrong (Ireland and Spain..)?

Next we have the wealth effects from rising stock markets. At best they have been small when measured and let me now formally remind everybody about yesterday’s discussion about inequality in the UK. So now a relatively small group will benefit even more in the Euro area as we cue similar discussions there. Yet more central bank front running by an establishment with all the self-awareness of Malcolm Rifkind.

Oh and if you look at the Euro economy it probably was not necessary. For example Germany – the biggest QE beneficiary – saw economic growth of 0.7% in the last quarter of 2014. There have been plenty of times in history that this would have been considered a success not a chance to ease policy! Some countries need help. This used to be done by regional policy.

On the other hand it does help with public (and indeed some private) sector debt burdens which were being raised by negative annual inflation. That is in my view the true rationale as we move towards debt monetisation. Let me hand you over to the purple one.

Sign O the Times mess with your mind
Hurry before it’s 2 late

In France a skinny man
Died of a big disease with a little name
By chance his girlfriend came across a needle
And soon she did the same


11 thoughts on “The ECB and Quantitative Easing A debt monetisation experiment?

  1. Europes shared history? As most countries in Europe gave been at each other’s throats for the last thousand years or so I suppose the current state of the Eurozone could be said to be drawing on a shared history,!

  2. Next moves if this should fail , and fail it will. After all what chances are there for QE to work for the economy

    on silly me!

    Its the Banks again , isn’t it ? 2008 ? pfft! here we are in 2015 and they are still bust and require asset prices to rise to stay afloat ……

    This could go on for 30 years you know , the parrots finger has changed !

    OK , next move negative rates , more QE , more negative rates rise and repeat…..

    watch for the warning signs that the bubbleliious stock market crash …. then cut an run !

    Black Swans ?? perhaps a another bank run , or oil going up in price , hope I wrong …..


    PS: by September on oil , there’s a stake in ground for you , but as Yogi said,

    “It’s tough to make predictions, especially about the future.”

    • Hi Forbin

      Thanks for the reminder of the Yogi Berra quote as they regularly raise a :).

      It is interesting to consider how far the trend to negative rates will go. I was reading some ECB research earlier which called -0.2% the “lower bound”. Is that the same lower bound that Mark Carney of the Bank of England thinks is at 0.5%? Also how do they explain both Denmark and Switzerland being at -0.75% i.e well below the ECB’ lower bond and far far away from Governor Carney’s.?

      I see the corn price is falling this week but doubt it was the reason behind the half price Butterkist toffee popcorn offer I took advantage of at the weekend. Perhaps I should have stocked up! Or accordingto economic theory delayed my consumption and not bought any!

      Oh and in the melee last week I did not get the chance to reply to the geographical issue you raised. My mum’s house (seems odd writing that) is in the Farnham area, hence going to Frimley Park Hospital. But I have returned to Battersea now and she is here for a rest/recovery.

  3. Hi Shaun,

    This poses a problem as if you use market prices to value things as I often do you sometimes have to face up to the fact that the 12%+ of 2011 and the less than 1% of 2015 cannot both be right! Yes Ireland’s circumstances have changed for the better but not on that scale.

    What do the wild fluctuations in bond yields and the unpredictability of the price of a commodity like oil tell us of the market’s ability to discover price? Do we like our EMH strong, weak or medium?

    • Hi Jim M

      Back in the day my earliest theme on this blog wias a discussion about price discovery. As you infer it has gone from bad to worse. Back then I was thinking of mobile phone tariffs,utility bills and the like. Now the list goes on and on and on.

      I went to the Public Meeting this afternoon on the Paul Johnson Inflation Report. Afterwards in a discussion with Jill Leyland of the Royal Statistical Society and Tony Cox of the RPICPIUserGroup (who had asked a good question about mortgage and savings rates) I raised these issues about interest-rates. My first point was that at times they are the price of money but at times they represent other things such as income. Also the links between different interest-rates were either weaker or broken. Even more so the standard deviation between different people’s experiences was now post credit crunch much higher. So rather than crude measures maybe we each need our own!

      Oh what a tangled web we weave…

  4. Yes Shaun, there are most likely aspects of neighbourly envy here. For all that the EU hate of the anglo-saxon abusive model and the US recovery I think they are both envious and somewhat cornered. Yes why can’t they have some of this luverly QE too, its taken 5 years to wear down the Germans , now they are desperate for some fake good news. I do fear unintended consequencies, you allude to a host of them. I’m just not sure of he “transferability’ of the model amongst so many countries with a shared currency, I suspect the wealth will pile up in a very lob-sided way and potentially be problematic rather than of universal benefit. Time will tell. Paul C.

    • Hi Paul C

      For all of the critiques of the Anglo-Saxon business/economic model which come from Europe there are more than a few countries which mimic it. Obviously Spain and Ireland took the housing bubble route but the there but the grace of God theme applies to the Netherlands and Denmark and whilst I have not fully investigated it I suspect Belgium too.

      The irony is that QE is now known to be much less effective than was hoped the five years ago that you mention.

      • The “Anglo-Saxon business/economic model…” is that the one which has needed so much wealth spent on keeping it alive (but comatose) that it has impoverished the greater part of us?

  5. Hi Shaun, I have said last year the falling oil price was good (short term) for all non oil producing but oil consuming economies and woukld give a welcome boost. I said at the back end of last year or early part of this year that growing M1 in the EZ would provide a further boost and ideally the ECB would do nothing, that remains my conviction. My main fear now is 2 – 2.5 years away when the M1 growth translates to inflation, the disinflationary effects of the oil price are long gone and the QE the ECB is embarking upon turns into further inflation wit a vengeance – a triple whammy. The European authorities are focussed on current disinflation and bent on douing “whatever it takes” to create inflation, the problem is that in 2.5 years time when they get hit by that lot they will have inflation coming out of their ears! Lets hope that an unforeseen development happens before then exerting downward price pressure on the triple whammy. Does my advocation of downwards price pressure as a counterbalance to the inflation being stoked up now count as heresy/treason these days?

    • Hi Noo2

      I agree entirely that it looks like the ECB is starting a pro cyclical rather than an anti-cyclical policy. Or the opposite of how a central bank should behave in my opinion. Should the oil price continue its current bounce (up 5% today) they will have egg on their face. I am bemused by the idea of the major QE beneficiary which is Germany possibly being in a growth spurt!

      As to heresy I would avoid trips to Venezuela if I were you! As should I…

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