Will Europe Drag Down The World?

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Steve Forbes
Steve Forbes

Steve Forbes is Chairman and Editor-in-Chief of Forbes Media. Steve’s new book: Money: How the Destruction of the Dollar Threatens the Global Economy – and What We Can Do About It, co-authored by Elizabeth Ames (McGraw-Hill Professional) comes out next month.

This article was originally posted on Forbes.

WHILE GREECE IS DOMINATING the headlines, two other recent pieces of news underscore why the EU is in a serious economic and political crisis that could have devastating consequences for the U.S. and the rest of the world.

One event is well known. The European Central Bank announced that it will embark on a gargantuan bout of quantitative easing to pull the continent’s stagnant economies out of their slump. The ECB is repeating the mistakes of the Federal Reserve and the Bank of Japan. It will be buying government securities (though, theoretically, the central banks of particular countries will bear the risk) to boost bank reserves and suppress interest rates. In a normal world banks would then boost their lending, taking this “high-powered money” and “multiplying” it. Once upon a time one euro of new reserves would end up creating ?8 to ?10 in new loans. Not now.

The rate of interest is the price a borrower pays for “renting” the money. Price controls always harm and distort markets. Suppressing interest rates has seriously distorted credit markets around the world, making it more difficult for new, small and medium-size businesses to get adequate credit at reasonable terms. Most households face the same situation.

Now we come to the lesser-known story: No sooner had the ECB embraced the Fed’s failed policies (it’s no coincidence that as the Fed wound down and ended QE, job creation in the U.S. improved) than the news came that the ECB would tighten capital requirements on European banks. Even institutions that meet regulatory capital levels today will be urged to beef up their capital cushions.

The ECB’s cluelessness is breathtaking. How does a bank increase its capital cushion? By selling new equity, cutting dividends–and making fewer loans. Regulators are obsessed with gauging a bank’s “risk-adjusted assets.” By the perverted lights of bank overseers, a loan to Portugal is less risky than a loan to Apple AAPL +1.66%. Politically unconnected businesses, i.e., most of the private sector, are shafted.

Most of the reserves created by this new version of quantitative easing will stay parked at the ECB. Worse, the ECB gives Europe’s politicians an excuse not to make the domestic restructurings that are needed to spark real growth, such as truly curbing bloated public sectors, slashing onerous tax rates and liberalizing labor markets.

Europe’s troubled economies will continue to stagnate. As the elections in Greece demonstrate, these troubles are leading to ugly political repercussions. France’s xenophobic, fascistic National Front has gained immense new support. Radicals are set to dominate Spain’s elections later this year. May elections in Britain could set in motion a train of events leading to the Sceptred Isle’s withdrawal from the EU.

A collapse of the EU and the euro would be disastrous, putting the world on a chaotic course not seen since the 1930s.

For the original article from Forbes visit: – http://www.forbes.com/sites/steveforbes/2015/02/11/will-europe-drag-down-the-world/

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