Despite some upbeat notes, the European economy continues to sing a melancholy song.
That wouldn’t be so bad if Europe were performing as a soloist. Unfortunately, it’s managing to drag the United States and Asia up on stage to provide a backup chorus.
Nobody wants this. Why can’t world growth be like it used to be before the recession?
What’s stopping a coordination of fiscal policy with monetary policy to achieve an old-style recovery?
For the answer, look no further than public budgets. From a fiscal perspective, rightly or wrongly, most governments feel their hands are tied. They are strapped financially.
Three factors have come into play: (1) excessive spending before the recession; (2) an excess of expenditures versus receipts during the recession to provide stimulus; and (3) anticipated huge outlays to support previously promised social programs in the decade or two ahead.
Almost everywhere, populations are aging. There will be severe demands on the public purse for health care, pensions and other forms of assistance.
Fairly or unfairly, this is leaving responsibility for further economic progress with monetary authorities.
Central bankers globally are doing their best to prod growth. They were accommodative before. Now, they’re virtually begging you to borrow money and spend it.
As of July 5, the Frankfurt-based European Central Bank (ECB) has cut its benchmark lending rate by 25 basis points (where 100 basis points equals 1.00%), leaving it at 0.75%, a new record low.
That’s not all. The ECB will no longer pay any interest on deposits left in its vault overnight by member banks. This is a move to encourage banking establishments to keep more of their extra reserves in circulation.
To further spur that effort, there has even been speculation ECB President Mario Draghi might adopt a negative interest rate. This would be territory rarely tried before by any central banker.
Such an observation overlooks the obvious. Almost all current central bank “real” (i.e., inflation-adjusted) interest rates are already negative. For example, the 0.00% to 0.25% range for the federal funds rate in the U.S. is accompanied by a 1.7% year-over-year increase in the Consumer Price Index (CPI).
The Bank of Canada’s 1.00% overnight rate is against a backdrop of 1.2% price inflation in May.
With inflation so relatively restrained at present, “real” interest rates are only mildly negative. But “taking a walk on the wild side” is what they’re doing nonetheless.
The Bank of England is going another route. Two months ago it halted its bond purchases. With growth so anemic, and the outlook still so bland, it’s been decided to reinstate the program. Governor Mervyn King has targeted another 50 billion pounds in asset purchases.
Buying more bonds is a euphemism for printing more money.
Ben Bernanke at the Federal Reserve has already extended Operation Twist, which is a financial maneuver to sell short-term treasuries and buy further out, thus lowering long-term interest rates.
As for the federal funds rate, it will be kept near 0.00% until the second half of 2014.
The People’s Bank of China is also getting into the act. Leading indicators on manufacturing and export sales in the country are suggesting more softness than anticipated. For the second time in a month, the official lending rate is being cut, this time by 31 basis points.
At the same time, individual Chinese banks will be allowed to offer a discount of up to 30% versus the official lending rate.
The one-year centrally-mandated deposit rate has also been lowered, but by a lesser amount, 25 basis points. The smaller drop is to encourage individuals to place more of their savings in the banking sector, rather than “under their mattresses.” The more money there is in circulation, the greater the stimulus there is for the overall economy.
Australia and Israel are two other countries that have recently cut interest rates.
In the great race to provide monetary stimulus, a side-effect can often be overlooked. There is a currency impact whenever a nation alters its interest rate policy.
For example, the latest ECB action immediately caused a further decline in the value of the Euro.
The creeping devaluation of the Euro is causing a severe problem for Switzerland’s national bank. The Swiss franc is seen as a safe harbor for those who want to divest Euros, believing the currency will continue to fall in relative terms.
This threatens to drive up the value of the Swiss franc and render goods produced in the country (watches, chocolate, cheese and precision equipment) uncompetitive in export markets.
The response of the Swiss banking authorities has been to buy Euros in whatever extreme amount will keep the franc steady.
No one knows how long this course of action can be sustained. It depends on how much extra money Swiss authorities are prepared to print.
So far, they’ve said they’re willing to go to any lengths to achieve their goal. But that’s what all beleaguered leaders say when they’re under siege.