Mario Draghi, the head of the European Central Bank (ECB), spoke to the Brookings Institution in Washington this week (http://www.ecb.europa.eu/press/key/date/2014/html/sp141009.en.html).
He was very keen to emphasise that the ECB would ‘do what it takes’ to avoid the Eurozone economies sliding into deflation and another slump.
And financial markets and the international economic agencies of world capitalism are worried. At 0.3% yoy, Eurozone inflation is now at a five-year low, far from the ECB’s mandate of keeping the inflation rate ‘below but close to’ 2%. At the same time, inflation expectations, i.e. how much households expect prices to rise, has also been falling. When expectations fall, people tend to wait for prices to fall before buying and prices stop rising as a result. It’s self-fulfilling.
There is a real risk that the Eurozone economy will stop growing at all and enter a deflationary spiral. Indeed, the IMF in its latest economic outlook reckons that the Eurozone now faces a four in ten chance of re-entering recession. Eurozone real GDP is stagnating and still below the peak of 2008 across the zone.
Even more serious, there is little sign of any recovery in investment and in the profitability of private capital in the Eurozone. Investment is still some 20% below the pre-crisis peak.
The lack of investment reflects the failure of profitability among Eurozone companies to recover. Indeed, according to my own calculations, taken from the Eurostat AMECO database, the net return on capital in the Eurozone is down at levels not seen since the early 1990s.
Low investment means that Eurozone companies are still not re-employing staff that they got rid of during the Great Recession. The official unemployment rate is stuck at well over 11%, a 20-year high.
On the broader measure of unemployment, which includes those in part-time work or who have given up looking for work, one in five workers in the Eurozone who want a job cannot get one. And of course, youth unemployment is huge, at well over 22%.
Financial markets have sold off in the last week because investors are now worried that the Eurozone’s stagnation and potential to slip back into slump could drag down the rest of the world economy. After all, Eurozone GDP is the same size as that of the US. The news that the German economy, the only one in the Eurozone that has been motoring, has taken a turn for the worse, was the trigger for the sell-off.
German exports plunged in August by their largest amount since the height of the financial crisis. German industrial production contracted 4% in August, the biggest decline in over five years. “The economy seems to need a small miracle in September to avoid a recession in the third quarter,” said Carsten Brzeski, an economist at ING.
This fear prompted Britain’s finance minister George Osborne to warn that: “the Eurozone risks slipping back into crisis, and Britain cannot be immune from that – it’s already having an impact on our manufacturing and exports,” he said. Osborne correctly pointed out that the world economy is just that: no country can escape from each other. “We are not immune from what’s going on in the rest of the world”. Of course, Osborne also has a political agenda. He is concerned to argue that, if the UK economy starts to falter after its recent ‘burst’ of growth (something I expect given the artificial nature of the current ‘boom’ – see my post, https://thenextrecession.wordpress.com/2014/07/10/uk-economy-can-it-last/), people can blame ‘Europe’ and not the policies of his government, with an election looming next May.
Draghi in his Washington speech reiterated the measures that the ECB is taking to avoid deflation and boost the Eurozone economy. The ECB has offered to lend to the banks credit at very low rates of interest for up to three years without much collateral as long as the banks lend this onto industry. These Targeted Long Term Refinancing Operations (TLTROs) started last month but the take-up by the banks was very low. So now Draghi plans for the ECB to buy outright batches of loans made to companies and mortgages by the banks, called Asset Backed Securities, and the banks’ own bonds (covered bonds) as a new way of getting credit into the ‘real’ economy. This will inject up to €1trn in new credit over the next two years.
The problem is that the banks don’t want to borrow money and certainly not lend it on to companies that might not pay it back. The banks are still struggling to get their own balance sheets in order (and they are about to face a ‘stress test’ of their viability by the ECB). The last thing they want to do is lend more on risky investments. Indeed, the Germans are opposed to Draghi’s new monetary measures because they will put the ECB on the hook to loads of loans that may not be paid back in a new slump.
The other problem is that there is no demand for credit. The large companies have plenty of cash and don’t need to borrow and the small companies have plenty of debt and little sales and so cannot get the banks to lend to them. You can lead a horse to water (credit) but you cannot make it drink (invest).
‘Unconventional’ monetary policy, or quantitative easing as it is called (huge dollops of low-cost credit printed up by central banks), has been the approach of the Federal Reserve, the Bank of England, the Bank of Japan and the ECB over the last few years. But it has visibly failed to boost the ‘real’ economy with companies investing more. Instead, this easy money has just inflated stock and government bond prices, enabling investors to make money speculating rather than companies investing in jobs and new technology.
The ‘monetary’ solution is not working, particularly in the Eurozone. That’s why the likes of Draghi and IMF chief Lagarde have called for fiscal action from governments. Having spent the past few years demanding fiscal austerity (balanced budgets, welfare cuts and debt reduction), now they want fiscal stimulus (public infrastructure investment), especially from Germany. “We’re not suggesting that the Eurozone is heading toward recession, but we’re saying there is a serious risk that happens if nothing is done. But we are saying also that if the right policies are decided, if both surplus and deficit countries do what they have to do, it is avoidable,” said Lagarde. Draghi hinted at the same thing: “For governments that have fiscal space, then of course it makes sense to use it. You decide to which country this sentence applies,” Draghi said (meaning Germany). Of course, the Germans have no intention of complying with these pleas for more government spending by them, having spent years trying to get the likes of Greece, Spain, Portugal, Italy and France to control their spending.
So the two arms of Keynesian macro policy, cheap money and fiscal spending, either don’t work or won’t be used, or both. The third arrow of policy action, to use the phrase of Japan’s Abenomics, is what is euphemistically called ‘structural reform’. “I am uncertain there will be very good times ahead if we do not reform now,” said Draghi. “Potential growth is too low to lift our economies out of high unemployment. Thus, while stabilisation policies that raise output towards potential are necessary, they are not enough. We need to urgently raise that potential.”
What Draghi means by ‘structural reform’ is ‘deregulating’ labour markets, removing labour rights, increasing the power of employers to sack workers, to impose new technology that loses jobs; to remove restrictions on shop hours, rent and price controls – indeed anything to allow market forces complete reign over all. This neoliberal policy is supposed to boost productivity, but in reality aims at raising profitability (which is not the same thing).
Keynesians like Martin Wolf (in a recent blog in the FT, http://www.ft.com/cms/s/0/89771ebe-43d5-11e4-8abd-00144feabdc0.html#axzz3FftZq7Er) reckon the Eurozone is close to another recession because of the lack of effective demand: “How are we to make sense of this predicament? The answer is that it reflects a prolonged slump in aggregate demand to which policy makers have failed to craft an adequate response.”
Draghi begs to differ. In his Washington speech, he referred to a letter by Keynes to President Roosevelt in December 1933. In it, Keynes tells President Roosevelt that the administration is engaged simultaneously in recovery and reform, and identifies a tension between the two. He worries especially about the risk that over-hasty reform impedes recovery. Draghi comments: “There are some parallels here for Europe: we are also engaged in reform and recovery. But in fact we face the opposite concern to that expressed by Keynes. Without reform, there can be no recovery.” Unlike Keynes, Draghi reckons that it is not more ‘demand’ that is needed to get the Eurozone economy going, but more profitability.
In a sense, Draghi is right. The problem of the Eurozone depression is not that it has been wrongly ‘managed’ by governments applying fiscal austerity, as Wolf claims. The long depression experienced by the world economy, particularly in the Eurozone, is a product not of ‘bad management’ but of the failure of the capitalist mode of production, as expressed in the collapse of profitability. The Eurozone may well need another slump to turn that around.
PS for my latest view on the Long Depression, an article in a recent issue of the Weekly Worker can be found here: