Costly side effects
One trillion euros in European Central Bank cash has poured like a balm onto the euro zone’s stormy waters – and helped drive up the global oil price. ECB liquidity cannot solve the euro zone crisis and comes with major risks.
The higher oil price is a risk that is already reality. Of course, there are supply side problems, most notably the threat to Iranian production. But no fundamental demand-supply imbalance can fully explain why the price of Brent crude has risen by 20 percent since mid-December-especially when much of the global chatter has been of only moderate expansion in the U.S. economy and of high risks to global growth.
The soaring oil price is part of a broader trend. Safe haven bonds are at record high levels, U.S. stocks at their highest in four years, gold close to a record high. Financial markets are buoyant because central banks have made them so. The list is long: two rounds of quantitative easing in the United States, further QE in Japan, a third round of QE in the UK – and now a 360 billion euro ramping up of the ECB balance sheet in three months. The central banks are pouring out huge sums of money. Inevitably, asset markets have gone up.
Nor is this a mere side effect. It is what the monetary authorities want. Rising asset prices bolster confidence, consumer spending and growth. The ECB welcomes the rally in Spanish and Italian debt as banks in these countries use ECB funds to buy their governments’ debt. But banks are not lending more. And oil price inflation is a big deterrent to global growth.
Germany’s Bundesbank is right to be troubled. Easy money comes with many risks. If, for example, Spain’s deficit is financed by banks in turn financed by ECB funds, the ECB is funding the Spanish government through the back door – and accumulating more risk itself. And by indirectly funding governments the ECB may delay reforms rather than promote them. Nor can it keep supplying funds without risking euro debasement and inflation.
ECB cash buys time but cannot cure fundamental solvency and competitiveness problems. The cheap fix has its costs.