We are fast approaching the time when it will become obvious to all that mortally-wounded economies cannot be resuscitated by a massive increase in credit from central banks. Nations that suffer from tremendous capital imbalances, debt capacities and asset bubbles cannot be healed by printing money. Quantitative easing and zero percent interest rates have the ability to provide GDP growth that is merely illusory and ephemeral. This is because it can temporarily levitate equity, real estate and bond prices, which causes an artificial boom in employment and consumption. But the “benefits†of making the cost of money free has its limits, and it also comes with dire consequences.
Further hope in economic growth generated from central banks is quickly fading because the transmission mechanism is now broken. Central banks can print money; but if new assets aren’t purchased by private banks there is less of an increase in broader money supply growth. Now that most central banks have set borrowing costs at rock bottom levels there isn’t much room to go lower. And it is becoming clear that governments are really good at creating asset bubbles, but woefully inadequate at creating sustainable growth.
For example, the Bank of Japan was fairly successful at creating inflation (YOY CPI up 2.4%), but after more than two years of Abenomics and its attack on the yen, GDP is lower today than in 2012. The growth dynamic isn’t much different in China, where GDP growth in 2010 was 5% higher than it is today, according to official government numbers, as the PBOC tries to slowly let the air out of an overwhelming fixed asset bubble.
But now all hopes for central banks to save the world rests on Mario Draghi and the ECB. Two years after promising to do “whatever it takes†to bring down skyrocketing bond yields, the ECB will officially start buying bonds in March. The problem is that Mr. Draghi’s well telegraphed move has only served to allow private banks to front run his bid. Therefore, sovereign bond yields are already near zero percent and any artificial benefit derived from lower borrowing costs has already been accounted for. And now these banks, which are saturated with EU debt, are now just waiting until March to say to Mr. Draghi, “sold to you.†But these same banks won’t be in any rush to make new loans with the ECB’s credit or buy additional sovereign debt because the assets in question offer virtually zero profit motive.
