Home Economic Trends ECB Inflationists are Crippling Europe – Alasdair Macleod (04/02/2019)

ECB Inflationists are Crippling Europe – Alasdair Macleod (04/02/2019)

Last week, the ECB announced the reintroduction of targeted long-term refinancing operations for the third time. TLTRO-III is scheduled to start from next September. The idea is to make yet more money available for the banks at attractive rates on condition they increase their lending to non-financial entities.

The policy is justified because the ECB sees growing signs the Eurozone economy is stalling, possibly badly. The weaker Eurozone economies are moving into outright recession, and Germany’s motor exports appear to have dramatically slowed, putting a constraint on her whole economy. 

The ECB’s reintroduction of TLTRO is an offer of yet more monetary and credit inflation, despite the evidence that unprecedented waves of monetary inflation in the last ten years have failed in all the objectives for which they were designed, except two: governments have continued to get the funds to spend without meaningful restraint, and insolvent banks have been preserved.

Only two months after its asset purchase programme officially ended, the inflationists are at it again. But one wonders why the ECB bothers to delay TLTRO-III until September. If it is such a good thing, why not introduce it now?

There is another explanation, and that is the ECB is intellectually adrift with no economic compass. We do not know how many economists and monetary specialists are employed in the Eurosystem, which includes the ECB and the regional central banks, but they are certainly not economists, otherwise they would understand money. They may be technicians, which is not the same thing. If they were economists, or more precisely properly schooled in the human sub-science of catallactics (the theory of exchange ratios and prices) they would more fully appreciate the consequences of monetary inflation. They would understand Bastiat’s broken window fallacy: it’s not what you see, but what you don’t see. They see the supposed benefits of inflation but appear blind to the strangulating burden imposed on ordinary people who make up the productive economy. 

The destruction and transfer of wealth from Eurozone savers to debtors and from the general public to the banks, government and large corporations are the principal and hidden consequences of monetary inflation. Monetary stimulation is progressively destroying Eurozone economies, which coupled with high taxes and excessive regulation has turned the Eurozone into one massive economic zombie. Any student of catallactics learns this early on. Yet, state-employed economists ignore the mathematics of dilution and are unaware of the changes in relative values people place on an unbacked currency, when they finally realise what the central bank is doing to it.

The ECB’s functionaries are similarly ignorant of catallactics as are their confrères in the other major central banks, but that must not excuse them from ignoring the contradictions inherent in their actions. They wield power, and that has responsibilities. Instead, they are trying for a third time a policy, that even if it appears to briefly succeed, emasculates the Eurozone’s economy even more.

Pumping yet more credit into the Eurozone is as effective as giving adrenalin to a dead horse. Lack of credit is not the problem. Put simply, there is a global momentum of economic contraction evolving, which any business and lending banker would be foolish to ignore. There is a developing crisis, the consequence of earlier monetary inflation in the credit cycle. Economic actors may not understand the origins of the crisis, but we can be certain they are becoming acutely aware of its looming presence. And as the crisis rapidly develops, those that require additional loans will already be insolvent. 

The signal sent by the ECB to lending-bankers is likely to be misinterpreted when credit contraction is the looming threat: if TLRTO-III is the smoke, there must be a fire, possibly out of control. Better surely to call in existing loans to businesses rather than waiting to be repaid from profits unlikely to materialise. An encouragement to lend early in the credit cycle is more effective and less likely to be misunderstood than a similar encouragement later in the credit cycle. This is why a renewed TLTRO policy will almost certainly fail. 

The inability of bureaucrats, with their heads buried in spreadsheets, to appreciate the role of human psychology is not the ECB’s only failing. Its executives do not even understand what interest rates represent, thinking it is simply the price of money. This is why it believes in keeping interest rates suppressed as a means of increasing credit. Earlier in the credit cycle, rate suppression does generate some credit expansion, mainly in financial rather than non-financial activities, because lower interest rates lead to higher prices for financial assets. That is basically a spreadsheet, almost non-human function. Large industrial corporations are opportunist, borrowing to fund buy-backs and to take over weaker rivals. Smaller and medium-sized business borrowers are usually offered credit only later in the cycle, when it is a mistake to accept it.

Consequently, in a zombie economy, such as that of the Eurozone, the only borrowers are wealth-destroying, socialising, debt-entrapped governments, taking full advantage of the Basel accords, which rates them for lending banks’ purposes as riskless borrowers.

The True Role of Interest Rates

Interest is not the price of money. It is a reflection of the difference between future values compared with present values. It has its origin in the human expression of time-preference. When a businessman agrees loan terms with a banker, they should reflect existing time-preference, so as to defer some consumption sufficient to fund investment. Anything else is a distortion with Bastiat-like consequences. Central banks have destroyed the basic function of capital intermediation based on time-preference by replacing savers with money and credit inflation as the principal source of investment capital.

This was wished for by Keynes in his General Theory, published in 1936. He wanted to see savers euthanised (his word) and for the state to provide the necessary capital to businessmen. He expected the entrepreneur to accept state direction of capital. Entrepreneurs “who are so fond of their craft that their labour could be obtained far cheaper that at present” should move from a risk-based approach to business to a socialising function.1

Keynes’s wish is granted posthumously, and ordinary people in the Eurozone and elsewhere are paying for it. Economic strangulation and wealth destruction are the consequence. Functionaries such as Mario Draghi and his fellow directors at the ECB are fully committed to pursuing these Keynesian objectives. Having promised their political masters economic salvation on Keynesian principals, they have delivered instead the Keynesian dream, but at the expense of the economy. 

Yet, the deferral of TLTRO-III to September suggests that in the back of their collective minds, the panjandrums at the ECB suspect they may be on a path to perdition. Or perhaps it is the influence of the few sound-money men left at the Bundesbank, across the road in Frankfurt, whose families suffered two currency destructions in the twentieth century and vowed never again.

But even they have been silenced. The protests against the ECB in the German and European courts are in the past. If, as this writer expects, the global economy proves to be on the edge of an abysmal credit crisis, there will be no meaningful objection to a further acceleration of monetary inflation to the point where the euro becomes worthless. If so, Mario Draghi will be identified by future generations as a latter-day Rudolf Havenstein, who famously printed the Reichsmark out of existence.

Unlike the Reichsmark, the euro is a cut-and-shut of a number of fiat currencies with very different time preferences. A knowledge of catallactics would have advised against its creation, proof if it was needed of institutional ignorance in matters of money and exchange. If its origin had been one currency, we could expect its demise to follow the path of all fiat currencies in the past. A single state granting itself the sole right to issue the medium of exchange can never resist the temptation to use it as a source of finance until its destruction. But the euro is a compromise between states with track records of widely different rates of inflation. What suits Germany does not suit Italy. The euro could face a quicker destruction, simply by the Eurozone falling apart.

However, Germany and a few Northern states like her appear trapped, this time through TARGET2 imbalances whereby the Bundesbank is owed approaching a trillion euros by the system. Inflation of money and credit, ultimately the cause of these imbalances, has taken the ECB beyond a point of no return. Inevitably, at some future point, ordinary people will replace their wishful thinking, that the ECB and the national central banks have control over the purchasing power of the euro, with a growing realisation that they don’t. And when they awaken to that reality, they will dump all euros surplus to their essential requirements.

We know that attempts by the authorities to side-step successive credit crises ultimately fail, and it is in that light we should look at TLTRO-III. We must conclude that it is a diversion, window dressing for the shop-front of a failing ECB. It will achieve nothing, because the banks do not want to lend to non-financials, with the exception perhaps of the most credit-worthy large corporations, the corporations that have the political class in their pockets.

It is not just the ECB following economically destructive policies, but an unholy alliance between big business and politicians, which is what Brussels and the ECB is all about.

  • 1. See Keynes’s General Theory, Ch 24. Concluding Notes.

Alasdair Macleod is the Head of Research at GoldMoney.