The physician has written the prescription for Europe’s fiscal woes.  The Euro-zone will have its own dose of Quantitative Easing (QE) as announced by European Central Bank President Mario Draghi. The prescription is a projected $1.24 Trillion dollar infusion beginning in March 2015.  As prescribed this is a ‘one-time fill only’ bottle, but can we speak honestly?  So was the prescription for QE in the US.  Wall Street was talking about QE4 as recently as October. (Source)

The central bank’s president is attempting to fend off deflationary pressures in the Euro-zone and help to bolster the region’s painfully low interest rate.  QE has been used to varying success in other economies.  The U.S. Federal Reserve Bank decided in the throes of the global financial crisis to embrace QE and many attribute that decision to saving the United States from a second great depression.  The Bank of Japan is attempting to utilize QE to overcome their long-term zero interest rate problems.

We would argue that with high rewards (curing financial ills) comes an equitable level of risk.  Europe’s central bank must commit to buying as many securities as is necessary to fulfill its inflationary goals.  The ECB President’s commitment to do whatever it takes must pass muster with Germany, considered the most economically powerful country within the zone. Of concern is the potential for fragmentation between the haves and have not’s.  The core countries with relatively strong balance sheets and governance must agree with large scale stimulus that may benefit the countries on the periphery more.

Potentially confounding the ECB’s efforts are individual countries taking their own measures, as illustrated recently by Switzerland.  The Swiss surprised the global markets by announcing the abandonment of the unilateral cap on the value of the Swiss Franc against the Euro.  Their central bankers foresaw the large capital inflows coming from the ECB’s announcement and took aggressive action.  Overnight, U.S. investors awoke to the news that the franc rose 40% against the Euro.

Europe is the latest patient to undergo this treatment; one that has become quite fashionable in solving countries’ stalling economies.  What does the Euro-zone stand to gain?  Potentially some control over the costs of public debt for those countries that make up the periphery.  Consider the action similar to that of an emergency asthma inhaler.  The medicine doesn’t really cure the illness, but it does allow for easier breathing.  Hopefully this will allow governments to set their fiscal houses in order, where true change is needed.

In our opinion this is bad voodoo medicine.  Not unlike voodoo, the mind might be tricked into thinking the body is healthier but the underlying problem is not addressed.  With sluggish demand, large burdensome debt and broad-based deleveraging in progress deflation remains a very serious threat.  Our belief that direct government interference in capital markets (whether necessary or not) invariably creates dislocations e.g., the US housing bubble and Japan’s lost decade(s).

We don’t mean to suggest that a poor outcome is inevitable for the European markets, only that our estimated spectrum of potential returns ranging from very good to very bad has widened. Said another way the future is less certain.  However experimental treatments are what you’re left with when traditional remedies prove ineffective. EU you’re in our thoughts, get well soon.