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Caught in a currency trap! How can the ECB save itself?
The content below was translated by Tencent automatically for reference.

SMM News: the European Central Bank will hold a meeting next week, and markets expect the central bank to make a major decision on a new stimulus package to boost economic growth and inflation. However, economist Daniel Lacar (Daniel Lacalle) recently wrote that the ECB has fallen into a monetary policy trap and that further easing will only increase the long-term risks facing the central bank.

Lacalle points out that the ECB has been inflating debt bubbles in the euro zone, while the slowdown in Europe's major economies has not improved. The tools that governments used to spend time designing in order to carry out structural reforms and reduce imbalances have now become a dangerous incentive to perpetuate overspending and increased debt under two very harmful and wrong excuses. And there is a misconception that there is no long-term risk in the euro zone because debt is cheap and free of inflation.

He believes that low borrowing costs are no excuse to increase debt. Japan's debt cost is low enough, but the cost of paying off public debt accounts for almost half of Japan's tax revenue, which was 15 times its tax revenue in 2018. If the ECB continues to ease its policy, it will only put it in the same way as the BoJ.

Eurozone bond yields have been artificially low, but low yields are not a sign of credibility and low risk. They create a fake sense of security, which is completely shrouded in extremely low interest rates and excess liquidity.

The ECB's balance sheet has inflated to 40 per cent of eurozone GDP, while at the peak of quantitative easing, the Fed's balance sheet has not yet reached 26 per cent of US GDP.

The Fed has never bought more bonds than net issuance. The ECB, on the other hand, continues to buy back bonds at maturity, although the size of repo has doubled and reached seven times the size of net issuance.

The euro zone has a liquidity surplus of more than 18 trillion euros.

As can be seen from the above data, although the European Central Bank says there is no inflation, this is not the case. The bubble in the euro zone is already huge, with prices rising by 40% since 2000, with little increase in productivity, with the exception of large bubbles in financial assets.

Lacalle also stressed that cheap debt costs must not be used as an excuse to increase debt, but should be seen as an opportunity to reduce debt, otherwise it would only increase the long-term risk to the economy.

The ECB, which seems to ignore these risks, believes that increased liquidity will boost economic growth and inflation, but after pouring 2 trillion euros into the market, it still fails to meet its target, and debt risk is rising.

To make matters worse, when markets are artificially exaggerated because of central bank policies, eurozone governments see low yields as some kind of market feedback on their policies. This is like self-consolation, causing many European countries to abandon the motivation for reform. Many believe that the current solution to the eurozone's low growth is to repeat the wrong policies of 2008.

The real problem for the eurozone, says the Daniel Lacalle, is that it relies entirely on the stimulus effects of monetary policy to strengthen economic recovery, focusing too much on a single goal and reducing the cost of public spending, no matter how costly it is. This will perpetuate structural imbalances in the eurozone economy, blur perceptions of risk and weaken economic vitality as long-term risks rise. Now, the ECB's monetary policy seems to have gone from an instrument of support for reform to an excuse not to implement it.

The ECB has fallen into a monetary trap, and if it normalizes monetary policy, markets will move away from the era of low yields, and governments may react. However, if it continues to implement its current policy, the bubble will grow and the risk of a repeat of the eurozone economic crisis will increase. As a result, Lacalle believes it may be time for the ECB to raise interest rates and stop buying back maturing bonds at a time when markets remain optimistic.

currency trap
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