A Better Alternative to QE for Europe

Despite all the advertising, launching quantitative easing (QE) in Europe may well be counter-productive. This is due in no small part to significant structural differences between the U.S. and European economies and capital markets.

But that does not mean nothing should be done. There are alternatives to giving more money to governments, banks and speculators.

The ECB should give the money directly to the 320 million citizens of the Eurozone. The rumors currently going around the upcoming QE program suggest that the ECB aims to spend one trillion euros. This would equal 3,000 euro on a per capita basis.

“Helicopter-drop”

Such a “helicopter-drop” – first envisaged by former U.S. Fed Chairman Ben Bernanke – would be fairer than encouraging further speculation and bailing out banks. In addition, each citizen in the Eurozone would be treated equally. There would be no hidden redistribution of wealth between countries.

Currently, we face the following situation: Imagine you are in a bar and free beer is offered. Unfortunately, only those standing directly at the bar have access to the free beer. It does not reach any of the other people in the room.

In a similar vein, so far it is only governments and banks who profit from the ECB’s generosity, while the real economy has no benefit.

As human nature would have it, the people standing at the bar ask for more beer, pointing to those in the room who have not yet gotten a glass. But when it arrives, instead of passing it on to the back rows, they once again drink it all by themselves. If we want to overcome this very unequal and suboptimal stimulus, we need to give it to everybody directly.

Japanese “solution” in the end?

As attractive as it would be to pursue the idea of a helicopter-drop, it remains highly improbable to be implemented. The master plan for Europe seems to be a different one.

As QE 1 will not produce the proclaimed, but unrealistic goals, it will only be a question of time until QE 2 arrives. As in the United States, the UK and Japan before, the ECB will become the biggest creditor of (in its case, Eurozone) governments.

It won’t take long until the ECB will be pressured to cancel the debt it holds. Such calls have already been made in the UK and in Japan. Senior economists, including the venerable Adair Turner, former head of the UK’s Financial Services Authority, even see it as the miraculous and pain-free solution to all our problems.

The vision they hold out is certainly alluring: The debt overhang would be gone overnight and the economies could recover.

It would not be the first time this has happened in the Eurozone. Already, in early 2013 the Irish central bank financed the government directly. It bought bonds from the government to fund the Irish bank-restructuring program. These bonds have a duration between 25 and 40 years and the interest payment from the government is wired back to the government from the central bank as profit distribution.

The FT summarized this very clearly: “This is monetary financing for all intents and purposes. The whole structure of this agreement is so convoluted that newspapers do not report all the relevant details. As always, convolution has a purpose. It renders legal what would otherwise not be, and it allows for obfuscation.”

Critics see it as Weimar-style economics, leading to a loss of trust in money and high inflation. In spite of warnings from highly regarded institutions like the Bank for International Settlements, it is a reasonable scenario. It is too tempting for politicians not to go this way.

Risk of a big bang rises

Assuming this as a still somewhat hidden master plan, it would still need several years to be implemented. Germany and other creditor countries will push back against more QE and resist any crisis “solution” via the balance sheet of the ECB.

In the end, when faced with a disastrous break-up of the Eurozone or a political gamble with the ECB, future German leaders will likely end up supporting the gamble.

Of course, the outcome of this mega-gamble will be unknown until tested. Japan might well show the way in a few years’ time.

The main risk for this political strategy is the electorate in the crisis countries of Europe. How long will Italians, Spanish and French voters accept the economic crisis and support the current strategy of dealing with it?

It could well be that the radical scenario outlined above takes too long to mutualize European debt. That suggests that one country – in my view, Italy is the prime candidate – decides to leave the Euro.

This might be not possible in a strictly legal context – but experience shows that, in real European crises, past treaties are simply not that relevant. Or will Brussels send an army to enforce membership? Surely not.

Once a country leaves, it will be difficult to keep the club together. But before the creditors of the northern countries celebrate the thought, they need to be reminded that they will also lose a big part of their money in such a scenario. There is no pain-free solution.