ECB’s escalating clashes with Germany

ECB European Central Bank
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In bare-knuckles European infightings, one might call the European Central Bank's (ECB) latest "whatever it takes" stimulus program the South's (aka "club Med") bitter-sweet revenge.

That is also a stark reminder of euro area's long running north-south fault lines. When Romano Prodi, Italy's former Prime Minister, saw the widespread creative accounting by countries trying to meet budget and public debt rules for the monetary union in late 1990s, he chuckled: "Well, we can also show you a trick or two." Indeed, the double entry bookkeeping was invented in the 15-century Italy by Tuscan savants.

Led by France and Italy, the euro area's unemployment-ridden and heavily indebted southern wasteland has been waiting for its moment to strike back at Germany's austerity diktat. That moment has arrived, with the overwhelming support of the ECB's Governing Council last Thursday.

Investors, therefore, should pay no attention to largely irrelevant arguments of euro area's price deflation as a policy mover. The ECB's decision for a massive monetary creation is an eminently political action in an environment where unnecessarily harsh austerity policies have unleashed powerful forces of protest and discontent in Greece, Spain, Italy and France – economies representing more than half of the monetary union.

These forces are closely connected and cutting across entire political spectrums.

At a huge rally in Athens last Thursday, Alexis Tsipras, the leader of Greece's radical left parties (Syriza) – a widely expected winner of today's elections -- was standing at the podium next to Pablo Iglesias, the leader of Podemos, Spain's upstart left-wing party currently polling at about 30 percent. And, in a completely unexpected event, the Greek radical leftists also got a strong endorsement from France's far-right Front National, credited with 28 percent of votes in next regional elections. All these parties are fiercely opposed to policies that have led to their countries' rising unemployment, poverty and growing indebtedness.

Back-door fiscal easing

What is Germany saying to all this?

Official Berlin's deafening silence about the ECB's new stimulus is in sharp contrast with hostile commentaries from the German media, including the Deutsche Welle, the country's public news service. German analysts see no economic rationale for the ECB's new stimulus because they don't see any danger of a euro area price deflation. They are outraged that cheap and abundant cash will be given to South European banks and governments, which they accuse of being unwilling to implement structural reforms and sound fiscal policies.

Read MoreWhy we were right on QE: ECB board member

German Chancellor Angela Merkel has been warning for some time about the reform backsliding by heavily indebted euro partners. Her latest comments came last Monday (January 19) during the New Year party at the German Stock Exchange in Frankfurt. With the ECB's President Mario Draghi in attendance, she repeated once again that the ECB should not ease the pressure on euro area countries to conduct structural reforms and tight fiscal policies.

Are the Germans right? For the most part, I think they are.

The ECB's deflation fig leaf is clearly an exercise in obfuscation. The 0.2 percent decline of euro area inflation in December is entirely due to the 6.3 percent drop in energy prices. Excluding energy, inflation rose 0.6 percent last month – almost exactly what it was in the entire second half of 2014. But inflation in the service sector – part of the economy that is mostly sheltered from competitive forces -- was 1.2 percent, and it was stable at that level over the previous six months.

Wages in the euro area are also increasing; they are estimated to have risen last year by 2 percent, pushing unit labor costs up by 1.5 percent.

Germans are also right in suspecting that ECB's huge liquidity provisions will lead southern euro area members to ease up on their reform efforts, because the cheap public debt financing will bring deficits down without any particular measures of fiscal consolidation.

ECB's policy transmission remains broken

Doubts expressed by German observers that the liquidity created by ECB asset purchases will not find its way to businesses and households are also well founded. Clearly, the euro area banks will not rush to lend (i.e., accumulate bad credit risks) in a recessionary economy. Looking at the U.S. example, one can see that American banks' lending to consumers began to pick up only last spring – after three phases of aggressive "quantitative easing" that began in November 2008.

Germans, however, have erred – and are still erring -- on two crucially important issues.

First, it is unrealistic to expect that largely unreformable countries like Italy and France would suddenly – and under stentorian German pressure – create and embrace fully flexible and competitive labor and product markets. Also, Spain and Greece have made considerable progress in reforming their economies and bloated public sectors. It is probably a good idea to stop pushing them to do more. Let them pause for a while to digest the huge erosions of their welfare states before proceeding to next stages of social and fiscal adjustments.

Second, Germans have imposed unnecessarily fast and large budget cuts in indebted euro area countries under conditions of declining demand and rising unemployment. They have also aggravated the financial burden of debtor countries by dragging their feet – for domestic electoral reasons -- on the euro area debt management, and by stoking market fears about sovereign defaults. That was wrong, unacceptable and – as we see now -- politically intolerable.

Investment thoughts

As was the case in the U.S., the soaring liquidity created by ECB's planned asset purchases will take time to increase the monetary union's bank lending to the private sector. The only immediate help to the region's economy might come from cheaper exports to the vast and growing dollar currency area.

The ECB's coming liquidity avalanche will also ease euro zone fiscal policies by reducing the burden of debts and deficits. That might leave some room for support to demand, output and employment.

Obviously, the increasing liquidity will be a boost to euro area equity markets.

The ECB has become a locus of quasi permanent and systematic policy clashes with Germany. That raises serious long-term issues about the monetary union, but that is a topic for another day.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.