The risk of repeating 1992
In contrast to what the broader public supposedly believes, central banks can sometimes blunder. In the long history of money and central banking, failures and mistakes in fact are more the rule than the exception. What are regarded as today’s monetary policy “successes” may be reinterpreted, given a sufficiently long historical perspective, as huge errors. Only time will tell.
For central banks, previous mistakes can be signposts for current policies. As the famous saying attributed to Seneca goes: “To err is human, to persist in error is diabolical.” The extremely loose monetary policy pursued by the US Federal Reserve since the 2007–08 financial crisis becomes more understandable if one knows that Ben Bernanke, its former chairman, is a leading expert on the Great Depression. While the debate on what caused the Great Depression may never be settled, it is safe to say that restrictive Fed monetary policy in the late 1920s and early 1930s certainly contributed to it.
Moreover, in my view, the Fed’s current reluctance to raise rates, even at the risk of falling behind the curve, can be traced to the “recession within the depression” of 1937. Wrongly believing that the worst of the crisis was over, the Fed became tighter in its monetary policy too early, sending the US economy back into a tailspin.
The European Central Bank (ECB), still only a teenager, cannot call as much on its short past to steer its current policy. Though as Mark Twain once said, history might not repeat itself, but it does rhyme. The ECB’s predecessors have some experience that they could share.
Not least the mighty German Bundesbank (Buba). In 1992, seeing the German economy overheating after unification and fearing it could lose control over inflation, it hiked interest rates. The Deutschmark back then was the anchor of the European Monetary System (EMS). Other European central banks whose currencies were more or less pegged to the mark had to follow suit. But while hiking in 1992 was good for Germany, it didn’t make sense for Germany’s neighbors, whose economies were ailing and unemployment rates rising. The moves led to the EMS’s implosion in September 1992 (and the legendary USD 1bn profit George Soros made betting that the UK would leave the EMS).
Fast forward 23 years. While today the Eurozone is on the road to recovery thanks to the ECB’s quantitative easing (QE) program and other measures, this recovery is uneven. Germany leads the way, and its May unemployment figure fell to 6.3%, its lowest level in 24 years, just before the EMS crisis. France meanwhile, the second-largest economy, still lags far behind. Its May unemployment rate rose to a record high 10.6%. It now has almost 800,000 more unemployed people than Germany, despite having 17 million fewer inhabitants.
For the time being all eyes are on Greece and what a “Grexit” or a “Graccident” could mean for the Eurozone. But the bigger concern for me, as far as the long-term stability of the euro goes, lies in the disconnection between the German and French economies. If the former continues to pull ahead, feeling more and more wage and price pressures, it will pressure the ECB, sooner rather than later I presume, to abandon its QE program earlier than the promised September 2016.
Jens Weidmann, Buba president, has already stated that the ECB’s QE program should have never been launched in the first place. Christian Noyer, president of the Banque de France, is suggesting on the other hand that the QE program could extend beyond September 2016. The makings of a future clash are already in place.
While the Fed avoids old mistakes at any cost, even at the risk of committing new ones, it remains to be seen whether the ECB will repeat or avoid the errors of its predecessors.