Words, words, words (and it gets even wordier)…
This is the third time in the last three years I've used the famous Hamlet quote as the headline for one of my editorials. And once again the subject is the situation in the Eurozone.
What amazes me now is how much weight market participants continue to give to the words and statements of Eurozone officials, despite their lack of action. If you want a practical example of the theory of rational expectations not working, you needn’t look any farther. What has been going on in the Eurozone over the last couple of years could be best described as a theory of willing deception.
The first time I used the Hamlet headline was back in August 2011, in the aftermath of a summit between then French President Nicolas Sarkozy and German Chancellor Angela Merkel. Three things were decided at it: 1) a European economic council would be created; 2) a balanced budget rule, to be written in the constitution of each Eurozone member country, would be installed; and 3) a tax on financial transactions, the so-called Tobin tax, would be levied.
Three-and-a-half years later none of these decisions has been fully implemented. Moreover, most people don't even remember this French-German summit, which was regarded by pundits back then as a “last chance.” Indeed, many more “last chance” summits, which are now the rule, not the exception, have followed.
More memorable was the second event that occasioned the headline. It occurred in summer 2012 after European Central Bank (ECB) President Mario Draghi single-handedly stopped the euro crisis by declaring: “The ECB is ready to do whatever it takes to preserve the euro, and believe me, it will be enough.” His menacing pronouncement worked its magic.
Market participants believed that Eurozone quantitative easing (QE) with massive government bond buying by the ECB was a done deal and imminent. And they have continued to believe so for another two-and-a-half years, front-running the ECB, which hasn’t even left the starting blocks yet. Yields on government bonds of the peripheral countries fell dramatically. In Spain for example, they dropped from an unsustainable 7.5%-plus in July 2012 to a record low 1.85% today. Draghi continues to reassure believers just by talking. In recent weeks he explicitly hinted that it's always possible more measures will be adopted than have been announced so far.
However, growing numbers of economists, I among them, question whether more monetary stimulus will really deliver the Eurozone from its misery. In fact, we might be in a Keynesian liquidity trap, in which monetary policy no longer has much impact and a fiscal impulse actually offers maximum leverage. In my view, this is why many European politicians are now thinking out loud about some kind of fiscal stimuli.
Chief among them is the newly elected European Commission President Jean-Claude Juncker. He recently unveiled an ambitious EUR 315bn “last chance” investment plan. However, you discover when you read the fine print that it is far less ambitious than the marketing for it makes out. Ultimately, only EUR 20bn will stem from the public sector. The rest is supposed to come from the private sector, through financial engineering (with a leverage of 15) and public guarantees of losses, which call to mind the (in)famous collateralized debt obligations (CDOs) at the heart of the 2007-08 financial crisis. German officials have already expressed reservations.
Aware that something must be done, and true to the political rule that “if you don’t want to make a difficult decision, create a commission to write a report,” French President François Hollande and Merkel asked two economists (Jean Pisani-Ferry of France and Henrik Enderlein of Germany) to brainstorm. According to their report, published last week, France should launch additional reforms and Germany should invest more. Gee, really?
This joint French-German report at least concludes with sober wisdom and self-awareness: “Our last words are simple: France and Germany spend a lot of time in common declarations and joint initiatives. What we lack are the acts.” Polonius, listening to Hamlet, could have rightfully added: “Though this be madness, yet there is method.”