Germany needs to help rescue Europe
Few doubt it was European Central Bank President Mario Draghi’s July 2012 commitment to do ‘whatever it takes’—this is what led to the ECB’s open market transactions—did a lot to lift sentiments, and growth prospects, in Europe as bond yields in the PIIGS countries crashed—even today, yields on Spanish and Italian debt are at 2%+ levels from the 6-7% levels they were at before Draghi’s statement. So much so that, in even its latest outlook, while the IMF downgraded both US and emerging market forecasts, it stuck to its 1% EU forecast. With the EU back in crisis mode, however, it is time to revise that forecast, and in a very big way. Not just is there the crisis over Scotland’s possible leaving the UK, and Catalonia leaving Spain, growth in the EU is spluttering badly. Both Germany and Italy contracted 0.2% in Q2 while France remained flat. As a result, the GDP of the 18-nation EU stayed flat in Q2, even lower than the previous quarter’s anaemic 0.2%. Which is why, Super Draghi’s latest salvo provides fresh hope; indeed, it has most global investors bullish since they sense a sharp delta should it work. In order to get banks to lend once again, Draghi has promised the ECB will buy asset-backed securities to help free up the balance sheets of banks. While the ECB already gives banks cheap, long-tenure loans to lower funding costs, the securitisation program will help transfer risk, and so release more capital for lending.
What is limiting Draghi, though, is the refusal of bigger European governments to play along. As a result, as Draghi reminded us, the level of business investment in the euro area has only slightly improved since 2008. “Only if structural, fiscal and monetary policies”, Draghi reminded leaders, “go hand in hand will the euro area see investment return... (the) policies (need to) mutually reinforce each other”. With Germany’s current account surplus expected to be around 8% of GDP this year, it is obvious which country has the most room to manoeuvre. But, as in the past, Germany is unwilling to run up the kind of deficits needed to stimulate demand in the area. While Germany is right in asking for structural reforms, the crippling levels of unemployment can’t be tolerated by countries for too long—certainly the Scotland events are a reaction to this. With inflation levels at just 0.3% as compared to the ECB’s 2% target, a Japan-style deflation looks increasingly likely. Even Super Draghi can’t fight this battle alone.