WE ARE EXPECTING THE ECB, BUT WILL WE GET THE FED INSTEAD ?, by François Leclerc

Guest post. Translated from the French by Tim Gupwell

The U.S. Federal Reserve’s Open Market Committee is due to meet on Tuesday and Wednesday, in the context of a renewed slow-down in the country’s growth  (+1.5% in the second quarter), which has been apparent since the beginning of the year. What will be decided upon this time?

Two successive quantitative easing operations, nicknamed QE1 and QE2, have enabled the Fed to inject some 2.3 trillion Dollars into the purchase of Treasury bonds or securities issued by mortgage refinancing organizations. In the light of the mixed results of the two previous ones, a third operation of monetary creation has yet to be confirmed.

Still, the Fed has not stood idly by, having launched and then prolonged a 647 billion Dollar programme known as ‘twist’, which aims to lengthen the maturity of the debt it already holds in order to push down long term security rates on the market, and to contribute to financing the debt over the long term through its purchases. To achieve this, it swaps securities it is already holding – short term for long term, which requires no new monetary creation. It has also announced that its benchmark interest rate will remain close to zero “until at least 2014”, in order to provide greater transparency and confidence to financial establishments.

Will it go further this time or not? We will soon find out. But another question will go unanswered, at least for the time being: that of what impact a new monetary injection might have? The debate on this subject has moved on, and the spectre of an unexpected inflation caused by repeatedly creating money, has been replaced by doubts about the Fed’s capacity to kick start the economic machine.  Ben Bernanke, its President, is now focusing all his attention on the risk of deflation and has not hesitated to say so.

The ‘head winds’ buffeting the economy have been blamed on the European crisis, thus conveniently avoiding any internal issues. The current electoral period does not lend itself to any kind of introspection or anticipation of what a newly elected president might do when he comes up against the fiscal cliff at the end of the year. In the absence of any agreement in Congress about deficit reduction measures, a raft of public expenses and tax reductions will automatically expire at this deadline, which pleases no-one but still allows them to blame everybody else. There is no more of a solution to the American debt problem than there is anywhere else.

The acknowledged impasse in the Eurozone is therefore not the only one. Its British peer is not faring too well either: according to a preliminary estimate of the National Statistics Office, the GDP fell by -0.7% in the second quarter. A reduction has been recorded for the third consecutive time, a recessionary phenomenon which has never been seen since 1955, the year when the quarterly statistics were first created. It is also worth noting that the definitive result is generally lower than the initial estimation.

The consequences have not been long in making themselves felt: fiscal revenues have dropped off (-£10.8bn) and benefit payments have progressed (+£15.4bn). From 944.6 billion Pounds in June 2011, the public deficit hit 1038 billion in June 2012. The British debt reduction strategy is not working, which hasn’t stopped David Cameron from pursuing it anyway, without dwelling too much on the distant date when it will start to produce some results. Buying more time, however, means drawing out the pain for even longer, something which is not unique to Great Britain.

The Governing Council of the ECB is due to meet on Thursday and will be under the spotlight. Following in the footsteps of Angela Merkel and François Hollande, Mario Monti has also declared that he will do whatever it takes to save the Euro – which is becoming almost a joke since nobody knows how to – but at least this is one thing everyone agrees on. Jean-Claude Juncker didn’t mince his words with this declaration to the Figaro, “How can Germany indulge in the luxury of deciding its domestic policies on the back of the Euro? If the other 16 countries all did the same thing, what would remain of the joint project? Is the Eurozone nothing more than a subsidiary of the Federal Republic? ”

Between now and Thursday, Tim Geithner, the US Treasury Secretary, will have met in turn Wolfgang Schäuble and Mario Draghi, in the hope of forcing some decisions. While there is no lack of hypotheses as to what the ECB might decide upon, there has as yet been no sign of any easing off in the German position which, when it comes down to it, seems to paralyze the ECB whenever it seems necessary to intervene in the bond market. It seems that Germany is still blocking any EFSF intervention, which in turn stops the ECB. That is unless it gets round it once again by financing the banks, so that they can buy up Spanish and Italian debt – something which would need the quality of guarantees required as collateral to be even further reduced. The independence of the ECB has once again been formally reaffirmed by the German Government, but the Bundesbank is keeing a close eye on things and is making this known. Before the meeting of the Governing Council Mario Draghi will have a meeting with Jens Weidmann.

Central banks are not what they were.