The sluggish eurozone


THE 19 countries of the eurozone present the odd spectacle of a single body, parts of which are well-muscled and healthy while others are flabby and sickly, if not indeed actually diseased. With the main exception of the non-eurozone UK destined, at some point or other, to cease to be the 28th member of the European Union, economic growth is not happening. At best, eurozone growth is expected to be 1.1 percent this year, with the hope of a minute increase to 1.2 percent in 2020.

The European Central Bank, (ECB) the guardian of the single currency which has now been existence for over 20 years, has been seeking desperately to stimulate economic activity. Even Germany, the EU’s powerhouse slid into recession at the beginning of year with two successive quarters of negative growth. Part of the problem there have been declining automotive sector sales, a key element in industrial output. However, compared with the likes of Italy and Greece, Germany finances are super-fit. And it is the precisely the reluctance of German banks and the financial authorities to loosen prudential controls on lending and borrowing, that is stymying rapid recovery.

What the ECB wants to see is inflation, as a sign of rising prices as demand outpaces supply and suppliers invest to increase their output of goods and services. ECB chief has therefore announced fresh stimulus measures to trigger some growth in eurozone Gross Domestic Product.

Banks depositing surplus cash with the ECB were already paying to keep it there. Draghi has increased this disincentive by adding a further “pip” to the negative interest rate, taking it to half a percentage point. The message is that banks should be doing better things with their money than locking it away securely. Draghi hopes that if they start lending this money, businesses will invest and expand and economic activity will pick up. The problem is that the banks, a lot of which are still technically undercapitalized, do not wish to take the risk of adding more bad loans to their already sometimes substantial portfolio of dud debt, which may never be repaid.

The ECB’s solution is to resume the program of quantitative easing it launched to bail out banks during the worldwide financial crisis a decade ago. Draghi has committed to buying up €20 billion of commercial bank loans every month from the start of November. The markets had been expecting the figure to be €30 billion, which perhaps demonstrates a level of incomprehension and despair at the eurozone’s seemingly intractable growth problems.

For the last five years the central bank in Japan has also been using negative interest rates and asset purchases to try and stimulate that country’s grounded economy, with still limited success.

And there is an irony to Draghi’s open-handed ECB policy. Companies are indeed borrowing but not in the way he would like. Rather than taking out loans to invest, managements are borrowing to refinance existing corporate debt on much more advantageous terms. Some companies are also borrowing to buy back shares. This merely increases the sums of investor cash slopping around in markets looking for reasonable and safe returns. The highest returns are now coming from the most risky debt, the junk bond markets, which are back with a vengeance. Tragically, we have been here before.