European Central Bank in Deep Waters

Posted on October 31, 2016 by ATB Chartered Accountants

The Euro experiment went astray from the start, causing a corrupt fiscal landscape.

The monetary union has warned that the European Central Bank is dangerously over extended, with €3,130 billion in total assets, growing its balance sheet by €53 billion in June alone. This level of asset growth is unsustainable, and officials warn that this framework cannot last by comparing it to a house of cards.

Otmar Issing, the first chief economist of the European Central Bank mentioned that the euro has been betrayed by politics, and the Eurozone has yet to overcome its structural issues. A combination of lower fiscal authority, cheap oil, a low euro and quantitative easing has effectively disguised the problems of the currency, however it is difficult to forecast how much longer it can last.

It is a myth that central banks have unlimited cash at their disposal, but their power is fairly limited given that they can only create bank reserves through buying assets from member banks or financial institutions. Through purchasing increasingly risky assets, central banks can also distort markets. This is the case with the European Central Bank. The chairman Mario Draghi promised markets that the ECB would buy €1,140 billion of government debt in 2015. This is problematic as the European corporate bond market is small and through extending this to government bonds, they are prolonging the inevitable collapse of the EU.

Issing commented on this by saying “Market discipline is done away with by the ECB interventions. So there is no fiscal control mechanism from markets or politics. This has all the elements to bring disaster for monetary union.” The ECB are muddling various roles, trying to be a banking regulator, rescue mission enforcer and also a monetary policy agent all in one go, and these sorts of behaviours have turned the foundations of the euro on its head, causing it to be sinking quickly.

The key problem is that the European Union was once a high debt state, but through buying government debts, the ECB have indirectly caused a 30% drop in competitiveness due to their fixed exchange system. In this system it becomes virtually impossible bounce back from the deflationary world we are in. The Eurozone structure has essentially acquired a contractionary bias where they are able to deflate in self-fulfilling manners, causing it to become a trap.