While the economic slowdown of the main European economies worsens, the ECB continues to disproportionately inflate the debt bubble of the eurozone. A tool designed for governments to buy time in order to carry out structural reforms and reduce imbalances, has now become a dangerous incentive.

Markets continue to see excessive spending and increase in debt as falling under two excuses: that there is no problem as long as debt is cheap; and that there's no inflation.

Personally, any rational person would not say that cheap borrowing is an excuse to increase debt in economies that are already having economic battles to stay afloat. Case in point is Japan that has a very low cost of debt, and the cost of servicing Japan's public debt is almost half of the state's tax revenues. As at 2018, Japan's debt was 15 times higher than the tax revenue collected.

From the 2000s up until now, the eurozone has seen an increase in inflation shows of 40 per cent represented through the Consumer Price Index, while productivity growth has been insignificant and salaries and employment remain depressed.

We have also seen a monetary policy change from being a tool to support reforms to an excuse for not implementing them.

Bond yields in the eurozone are artificially placed at their current levels and give a false sense of security that is completely clouded by awfully low interest rates and excess liquidity.

The balance sheet of the ECB has been inflated to be 40 per cent of the GDP of the eurozone, while at the peak of quantitative easing the Fed’s balance sheet did not reach 26 per cent of the US GDP.

To make comparisons worse, the Fed’s bond buy backs never exceeded net issuances, yet the ECB continues to buy back bonds once they mature which have exceeded net issuances by seven times.

Officials have been justifying such observations by saying that there is no inflation but it is very evident that there is. Financial assets are not the only ones that have experienced inflation. In general, prices in the eurozone have increased by 40 per cent since 2000 while productivity has barely increased.

The ECB seems to be ignoring the accumulation of imbalances and expects liquidity to generate the levels of growth and inflation that have not been achieved even after €2 trillion of expansion. In the meantime, the risks of debt saturation rise.

Governments all over the eurozone identify low yields as some kind of market validation of their policies, when markets are artificially inflated by the central banks' policies. Low yields are not a sign of credibility and low risk per se, but rather of financial repression and fear of a weaker macroeconomic environment in other assets.

The problem of the eurozone is that it has depended entirely on the monetary policy to strengthen the recovery, focusing on a single objective, to make public spending cheap to finance, whatever the cost. This prolongs structural imbalances, the awareness of risk is clouded and the economy becomes less dynamic while long-term risks rise.

The ECB set itself in a monetary trap. If it normalises policy, the illusion of low yields will disappear and governments will react against it. However, if it keeps the policy, there is an increasing risk of repeating a eurozone crisis without any tools to address it. That is why it must raise rates now and stop repurchasing maturities while markets remain optimistic.

Unfortunately, instead of proposing supply-side measures, restricting the excessive taxation and stagnating effect of government spending, more spending and more liquidity will be recommended as solutions that will make the economy even weaker.

The main problem with the accumulation of debt at low rates is that it has the same effect as a real estate bubble. It masks real liquidity and solvency risk, because borrowing costs are too good to be true.

This article was issued by Maria Fenech, investment management support officer at Calamatta Cuschieri. For more information visit, https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.