Friday 30 September 2016

Magic money unlikely to bring fairytale ending to epic battle in Greece

Published 09/07/2015 | 02:30

A Greek flag flies behind a statue depicting European unity outside the European Parliament in Brussels this week – the hard political reality is that when it comes to Greece against the rest, the rest is always going to win
A Greek flag flies behind a statue depicting European unity outside the European Parliament in Brussels this week – the hard political reality is that when it comes to Greece against the rest, the rest is always going to win

How much is a €10 banknote worth? The physical piece of paper itself is effectively worthless. But because everyone accepts that these banknotes are worth €10, we can buy all kinds of stuff with a value up to that amount with the notes. This is the magic of printed money.

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But the magic only works as long as people are confident that the same pieces of paper will be accepted as being worth the number that is printed on them. If that faith evaporates, people begin using other things as a "means of exchange". The last time that happened in Europe was after World War II. Then, cartons of cigarettes and nylon stockings were used as currency amid the devastation.

Most people know that having a reliable currency is vital - despite their vote last Sunday, opinion polls show that a big majority of Greeks want to keep the euro rather than change over to a currency that doesn't (yet) exist.

Most people also know instinctively that manufacturing lots of banknotes doesn't make an economy rich. The wealth creation process is a lot more complicated than printing pieces of paper - after all, if getting rich were as simple as running a printing machine we would live in a near utopian world in which no country or person wanted for any material thing.

In a week in which the European Central Bank in Frankfurt is at the centre of the Greek crisis, its decision earlier this year to print money as a means of boosting the flagging eurozone economy is a matter of curiosity to many, including our lawmakers. Yesterday, an Oireachtas committee asked this writer and two other dismal scientists to discuss the ECB's money-printing plan.

Because of the alchemy-like quality to 'quantitative easing' (QE), as it's known in economics jargon, it is viewed with suspicion in some quarters, and with more than suspicion in a certain large country right in the middle of Europe which experienced the disastrous effects of out-of-control money-printing in the first half of the last century.

Mainly because of Teutonic hostility, the eurozone came late to the QE party. American and British central bankers have been at it since shortly after their economies crashed in 2008. Japan - the first economy to dabble in the practice - began creating Yen out of thin air back in 2001, when prices of goods and services in its long-plodding economy began to fall.

So how does QE work?

Consider first a circumstance when inflation gets out of control. In response, central banks raise interest rates. Higher interest rates cool an economy by making borrowing more expensive and by rewarding saving over spending, among other things. Because there is no limit to how high interest rates can go, central bankers have a limitless amount of firepower to control inflation. But if prices start falling, central bankers hit a wall once official interest rates are at 0pc, as they are now for all intents and purposes all over the developed world. In order to get around this problem, they try to influence directly the many other interest rates that exist - from government bonds to bank's mortgage lending - in the hope of stimulating the economy by encouraging investment and by making spending more attractive than saving.

The most common way of doing this is with a QE programme that buys government bonds. That is because the interest rate on these bonds is a benchmark for other interest rates, all the way down to the rates banks charge their customers for mortgages and overdrafts.

That, in a nutshell, is how QE is supposed to work. But how has it actually worked in practice?

Readers may be dismayed to hear that economists do not have a good answer to that question. One reason is because the evidence is so thin. As mentioned above, the first time QE was tried was as recently as 2001 and since then there have only been a handful of cases. A second reason is because measuring its effects is difficult - in a modern economy in which millions of transactions are made every hour, disentangling the reasons affecting these decisions is impossible to do with any accuracy.

When economists at the IMF in Washington DC gave their best shot at evaluating QE in late 2013 they sounded suitably circumspect, saying that these measures and their impact "appear to have boosted growth and prevented deflation, although these effects are difficult to measure".

As it happens, this also described quite well the situation in Europe since early in the year - the indications in the eurozone have been quite good since the ECB followed its counterpart central banks in the other big developed countries and started QE. Economic growth has continued to perk up and there are signs that the downward trajectory towards deflation has been halted.

One of the side effects of QE is a weakening of the currency. Although central bankers deny that pushing their currencies down is an objective of QE, for fear that they be accused of fighting "currency wars", the euro has weakened considerably since Frankfurt signalled its intention to print.

This effect has been particularly beneficial for Ireland, given a higher than average share of exports that go outside the eurozone - mostly to Britain and America. But if QE appears to have been beneficial to date, it might also have contributed to the creation of yet another bubble in financial markets. That phenomenon was exercising the minds of TDs yesterday.

Exercising their minds to an even greater degree was Greece. And given the members of the committee present were mostly of a deep-red hue, their sympathies lay with that crisis-wracked country.

But whatever one's views on where the blame lies regarding Greece's predicament, whatever the rights and wrongs, and whatever economists say about what should or should not be done, the hard political reality is that Greece against the rest was and is always going to end in the rest getting their way. If the Athens administration does not bend by the weekend, Grexit will be upon us. If contagion is subsequently unleashed, the ECB might have to magic up a much more radical money-printing plan to prevent the Eurozone recovery from being derailed. We are living in very fragile and uncertain times.

Irish Independent

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