Time is money, hence money buys time - but how much?
The presidential elections are behind us, but market participants remain focused on the US. The threat that gridlock in Congress might push the American economy over the so-called “fiscal cliff” has not yet been reduced. We remain convinced, though, that some kind of bargain will be reached.
This short-term fiscal threat aside, the problem of the US public debt remains and must be dealt in the next few years to avoid greater damage to the economy. No country can afford a public deficit-to-GDP ratio between 5% and 10% over a longer period, as has been so for the US over the last five years. The sheer quantity is mindboggling: over 16 trillion US dollars (a 16 with 12 zeros behind it), which at its current pace of growth could reach 20 trillion US dollars in less than five years. Something needs to be done, but this will only be achieved in a long and tedious political process.
After the last European summit, French President François Hollande said almost exuberantly that the crisis of the Eurozone is almost over. German Chancellor Angela Merkel more prudently thought that Europe would need “a long breath of five years and more” to recover from the crisis. But even that seems almost too ambitious given what needs to be done before the euro is again on strong footing: setting up a fiscal union or some kind of federalist system to put a definitive end to the sovereign debt crisis, laying foundations for a banking union to halt the creeping bank runs in Southern Europe, leveling the playing field among the different countries in terms of labor and social laws to reduce the immense competitiveness gap between the Eurozone member countries.
Viewing this European institutional construction site, one sees - as with the US - that achievements will entail a long and tedious process. There have been over 20 European summits. In my view, another 30 to 50 will ensue.
Both reducing the ballooning public debt in the US and building correct institutions in Europe will take time. But markets are impatient. They want Angela Merkel and François Hollande to decide on a Federal Europe next weekend, or President Barack Obama and Republican Speaker of the House John Boehner reach an agreement on public debt by Thanksgiving. This is wishful thinking. Political processes are slow and more prone to setbacks than even those involved would wish.
This is not a critique. Checks and balances are part of democracies. Sixteen European governments have been ousted since the beginning of the euro crisis; so far only the Dutch Prime Minister Mark Rutte managed reelection. The time of politics is slow, while that of the markets is fast. How can these two times be reconciled?
Money helps, or if you prefer, central bank liquidity provisions ensure that markets don’t panic too much, when politicians again fail to reach an agreement. This is how I understand the monetary policies of Europe and the US.
Mario Draghi will do “whatever it takes” to save the euro. But ultimately only the European politicians can build the appropriate institutions to do this. Meanwhile, Mario Draghi buys time.
Ben Bernanke is unhappy with the level of US unemployment. Through the QE3 measures the Federal Reserve buys mortgage-backed securities. I have never read any academic economics publication relating mortgage-backed security buying with reducing unemployment. However, by lowering the interest rates on the long end of the yield curve, the US Fed ensures that the US public debt will not explode. Here also, time is bought for politicians to spend fixing this problem.
There is only one issue with central banks buying time. Politicians might get the impression that time is cheap - that they can continue to delay solutions. They could not be more wrong than that. In fact the longer they wait, the more expensive time becomes and the greater the central bank injections will have to be to buy even more time. But couldn’t that increase in the price of time be interpreted as a first sign of latent inflation?