Expectations for progress in solving the problems of the eurozone have fallen so far that even the smallest signs of progress are liable to be greeted more rapturously and invested with much more significance than they deserve.
Last Friday’s patched up deal to allow Spain and Italy to funnel bailout funds directly to their banks is one such small measure coming after 19 largely abortive summit meetings.
Europe’s divided political leadership may soon discover that their efforts to fix their flawed single currency project are merely a sideshow to the much bigger issues facing the world economy in the aftermath of the global financial crisis.
That at least was my interpretation of the extraordinarily downbeat annual report of the Bank for International Settlements, published a few days before the latest summit kicked off. As one of the few institutions that can claim to have warned publicly about the dangers of the global credit boom before it burst, the latest views of the BIS deserve a wider public hearing. The 83-page essay that opens the annual report abandons the normal opaque bureaucratic style of large international institutions in favour of some commendably frank language.
The BIS argument starts with some striking aggregate data. Since 2007, the year that the financial crisis began, government debt in the advanced economies has risen from an average of 75 per cent of GDP to more than 110 per cent. The average government deficit has ballooned from 1.5 per cent to 6.5 per cent of GDP. In response to the deteriorating economic conditions, the world’s central banks have loosened monetary policy and expanded their balance sheets so rapidly that their assets now amount to 30 per cent of global GDP, or roughly double the proportion 10 years ago. Real interest rates in most advanced economies meanwhile remain “substantially negative”.
It adds up to the largest injection of monetary stimulus that the world has ever seen, a lot of it made up on the hoof, and yet it has not only failed to pull the world decisively out of its post-crisis malaise, but also appears to be losing its marginal effectiveness.
The reason of course, as the BIS also points out, is that monetary measures – both conventional and unconventional – can only ever be “palliatives”, not cures for the problems arising from the reckless credit expansion that produced the crisis in the first place. Central banks cannot induce the deleveraging that is needed to restore government and bank balance sheets, cannot correct sectoral imbalances and cannot address solvency problems. That duty rests with governments, who have so far largely flunked the test. “Simply put,” the BIS concludes, “central banks are being cornered into prolonging monetary stimulus as governments drag their feet and adjustment is delayed.”
It is, unfortunately, difficult to fault this analysis, self-serving though it may be. As is already clear from the experience of the European Central Bank’s LTRO (longer term refinancing operations) programme, monetary measures can buy time, but they cannot guarantee that the time gained is well-spent. In other words, even if Europe’s political leaders can find a way to save the euro, it will not mean they have resolved the underlying structural problems of uncompetitive economies, undercapitalised banks and unaffordable social welfare commitments.
Nor will it resolve the wider fault lines in the global economy. Europe’s interminable struggles to rescue the single currency project have come to dominate sentiment in financial markets for most of the past two years. There seems little doubt that this in turn has been an important factor in harming business and consumer confidence elsewhere in the world, and contributing to the global economic slowdown. Emerging markets are now directly feeling the effect of Europe’s banks retrenchment, on their trade credit, for example.
But the point that also comes through clearly in the BIS analysis is that the limits to central bank effectiveness and the challenges to economic growth around the world will not suddenly end if and when the eurozone crisis is resolved. There are still too many weaknesses elsewhere in the global economy – too much debt, too many over-leveraged banks, too many unfunded promises – to make that a realistic expectation. The current generation of political leaders has so far shown little sign of genuinely recognising the scale and nature of the challenges they face.
It would be surprising if central bankers were not fretting over this unhappy state of affairs. As a breed they are not of course immune from criticism – anything but, given the role that easy money and inadequate banking supervision played in creating the current global crisis. Reformed sinners have a right to be heard however, and it would be a tragedy if the apocalyptic concerns of the author of the BIS report were to be ignored now.
Jonathan Davis 