The longer-term outlook, both for financial markets and for the eurozone economy, is anything but calm
The FTSE down more than 2%. German shares off 3%. Wall Street belly-flopping on its open. There was something very familiar and rather frightening in the way financial markets lurched about. And it can best be illustrated by this fact: the difference in borrowing costs between those for the Spanish government and those for Angela Merkel's administration rose to 3.88 percentage points – their highest since November. That was the month before the European Central Bank launched its emergency operation to pump money into crisis-stricken continental banks. In its so-called long-term refinancing operation (LTRO), the ECB handed out more than €1tn in ultra-cheap loans to banks. We now know what that €1tn bought the authority: a mere lull in the panic that has gripped the eurozone for more than two years.
Markets don't tend to move in straight lines, but zigzag about. It is quite possible that the coming days will see some calm, thanks to investors on the hunt for a bargain. But the longer-term outlook, both for financial markets and for the eurozone economy, is anything but calm. For one reason, the LTRO scheme is under increasing scrutiny both within European central banks and by independent economists. For another, it is clear that policymakers across the eurozone have no other shots in the locker should their cheap-loans policy fail. And finally, evidence is also mounting that pumping cash into the banking sector, either on the continent or in Britain, is doing little to help the real economy.
For the past four months, the ECB has done its best to revive a banking sector on the brink of collapse; what it has helped create, however, is a continent-wide pyramid scheme. The €1tn it handed out in two days, put together with various other official liquidity schemes, has certainly shored up desperate banks. They have used the money to buy the debt issued by their own governments. According to analysis by UBS, Spanish banks have taken a total of €250bn. In December and January, they increased their holdings of Spanish state bonds by 29%. In Italy, banks took about €260bn in official handouts; they promptly raised their holding of Rome debt by 13%. Europe's policymakers have propped up weak banks, who in turn have propped up Europe's policymakers. And, as ECB head Mario Draghi has himself admitted, there is next to no evidence that this historic infusion of vast amounts of cash has done anything to increase bank lending to businesses or households.
Public money, then, has been used to boost private banks, with very little obvious return for the public – apart from the temporary aversion of calamity. No surprise then that Mr Draghi and his colleagues are facing increasingly tough questions over the entire scheme. Nor should there be any surprise that the inflation-phobes at Germany's Bundesbank are pressuring the ECB to prepare an "exit strategy".
Mr Draghi yesterday dismissed any such talk as "premature", but the accompanying ECB communique laid as much emphasis on the risks of high inflation as on the lack of growth. Yet without a continuation of the LTRO, southern European governments will struggle to find takers for their bonds – just as Madrid did. The deepest spending cuts since Franco, as unveiled by prime minister Mariano Rajoy last week, will not help, because they will simply cripple the economy and so wipe out tax revenues.
The Bank of England is also under pressure to show results for its £325bn giveaway to the finance sector, otherwise known as quantitative easing. While the economy limps along, Mervyn King's gamble with QE looks just that – a gamble that has so far failed to pay off. In the eurozone and Britain, the use of monetary stimulus was always based on an ideological aversion to using government finances, let alone shaking up the banking system. Just how misguided that policy has been we shall see in coming weeks, as markets continue their sickening lurch.