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Saturday, 24 January 2015

ECB - government bond purchases - part 2

Well the plan has changed a little bit: Euro 60 - rather than 50 - billion per month until September 2016 (= 21 months) rather than a 12 to 24 month operation. Each national Central Bank will buy its own government bonds rather than - f.e. - the Dutch buying Italian government bonds. Interest levels went further down and the Euro too. Share prices went up.

ING has already publicly stated that it will not sell any government bonds to the Dutch Central Bank as ING does not need any further liquidity. Not a surprise given existing and abundant ECB liquidity schemes. Furthermore, liquidity hardly gives any yield as any bank - or its customer - is aware of.

Supporters of this ECB decision refer to earlier UK and US successes. Although these successes may be valid, the comparison is not. UK and US markets (e.g., capital, housing, labour) are extremely relaxed compared to "several" continental European countries. Pumping money into such economies does help boost their economy. Pumping money into rigid markets will merely create price inflation (more money while same volume of goods and thus the price per unit must increase).

Common sense dictates that companies do not start new ventures if interest - or taxation - is low. New business is based on expected profit predictions. A lower interest in Discounted Cash Flow calculations does indeed increase the outcome but higher volumes or higher gross margins have much more impact.

Someone once said to me that if you cannot earn a profit with an interest level of - back then - 6% then you should not even be in business in the first place. Indeed that is the heart of the matter.

This week it was announced that the Dutch are European champion in saving money. Balances have increased despite growing unemployment and despite very low interest levels. From a behavioral angle this makes perfect sense: saving money is related to expecting a negative future (e.g., unemployment) and the future need for cash. The now is far less important than the future.

So now what??

If the EU wants to make this massive money injection work then member states should A.S.A.P. remove obstacles for companies to start new business. The most important one is the labour market. Some European countries make it almost impossible - or cost prohibitive - to fire employees. These countries typically work with short term labour contracts that keep being renewed but almost never into a permanent contract. In such countries permanent is permanent indeed. Consequently, young people no longer join labour unions as these only represent elderly people with permanent contracts.

The majority of employment usually is within a huge number of (very) small companies. If labour regulations would genuinely be relaxed for small to medium sized (SME) companies then the results might be spectacular. Relaxing them for large companies would probably be even counter productive as they would finally have a way to loose excess capacity.

As always the future is in SME companies. Help them for a change rather than making their lives miserable with excess regulations.