… killing the pain coming from the cancer that is in European banks".
This was the assessment from an ex-Bundesbank president, former governor of the IMF, current professor at the University of Chicago and proposed chairman of UBS, with respect to the massive injections of liquidity to the markets (e.g. QE*, LTRO**) provided by the world’s largest central banks.
Axel Weber, speaking at a conference (Expert Investor Europe, Pan-European Congress) I attended on the 16th of this month, went on to review the effectiveness, challenges and risks of these experimental and expansionary global monetary policies, and talked candidly about his outlook for the major developed market economies.
In his opinion;
- The European economy will trail the rest of the world for some time to come. The Euro will not split up but will be a weaker currency. This is not a catastrophe, but no-one will love monetary union - it is "like a marriage, there will be discussions as to the limit for the credit card given to the partner(s) and whether they have to call before they spend on it."
- Italy "won’t have a problem… it is the richest country in Europe" (based on private net worth as a %age of GDP); Spain is a "borderline" case and Portugal is "more like Greece".
- European involvement in the bailout of Greece was a "big mistake, they should have left it to the IMF, having peers tell them what to do won’t work".
- Similarly, Merkel’s interference in French politics risks damaging the relationship between Germany and France, weakening the core at a time when the periphery needs it to be strong.
- "It is an illusion to think that 3 years post LTRO all will be ok." European banks still need massive capital injections. The biggest risk is the LTRO lures them into the perception they don’t need to de-lever. In addition, the banks are "selling their futures" by disposing of their best assets and keeping the secondary ones, naively believing the latter will be repaid at par. Circa €1 trillion notional assets need to be off-loaded from bank balance sheets.
- The US has entered a self sustaining recovery, sentiment has turned and the housing market is bottoming. However, committing monetary policy to calendar dates (e.g. FED to keep rates low until 2014) and not the economy is an "experiment which will end badly", resulting in "a huge overstimulation of the economy" and asset price inflation down-the-line.
- Migration is the new reality in Europe similar to the 1950s, as the Twitter generation won’t see language as a barrier. Greece won’t abandon the Euro but smart money and the young & qualified will leave the country.
- The UK will not default, instead it will attempt to inflate its way out of the debt problem, via currency devaluation & further QE.
Risk and asset markets are clearly enjoying the high these regular liquidity fixes induce, however as Mr Weber has cautioned, such non-conventional measures are not without risk and questions remain as to the consequences of their withdrawal.
* Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective. A central bank implements quantitative easing by purchasing financial assets from banks and other private sector businesses with new electronically created money. This action increases the excess reserves of the banks, and also raises the prices of the financial assets bought, which lowers their yield.
** Long-term refinancing operations (LTROs) have been around for years in the Eurozone; however, recently the European Central Bank launched them in a new form to help alleviate the debt crisis. Essentially, they involve the central bank lending money at a very low interest rate to Eurozone banks, which has led to the term "free money." The injection of cheap money means that banks can use it to buy higher-yielding assets and make profits, or to lend more money to businesses and consumers – which could help the real economy return to growth as well as potentially yielding returns.