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A Month Of Surprises

ECB Chariman Mario Draghi speaking with a microphone
ECB Chairman Mario Draghi. Photo courtesy INSM

We are less than one month into 2015, but it feels as though we have had enough major news to carry us at least into the dog days of summer - by which I mean summer in places like New York or Beijing, not Sydney or Johannesburg.

While geopolitical trends remain troubling, ranging from the Charlie Hebdo butchery and its aftermath in Paris to the fall of Yemen’s antiterrorist government to renewed fighting in eastern Ukraine, most of the economic news has been good. But there have been so many headlines that this seems like a good moment to take a step back and consider their implications.

The big financial story last week was the European Central Bank’s decision to launch a quantitative easing program, emulating steps that were long since taken here, as well as in Japan and the United Kingdom. The decision itself was not a surprise; the ECB’s hand was forced by dismal gross domestic product and inflation numbers that emerged in the final months of 2014. But markets were anxious about the details until ECB Chairman Mario Draghi stepped to the microphone on Thursday. He outlined a plan whose scope (60 billion euros per month), duration (at least until September 2016, and possibly longer if economic benchmarks are not met) and structure (20 percent of the program’s credit risk will be socialized among ECB member nations, reducing the exposure of any single country’s central bank to its own default) reassured markets that the eurozone countries are committed to addressing their monetary problems collectively. Stock markets here as well as in Europe rallied on the news, while the euro’s value plunged to about $1.12, down four cents in two days and down from around $1.33 at the start of 2014.

A QE program is no magic carpet that carries nations to prosperity. Japan has still seen little response outside of financial markets from more than two years of “Abenomics.” It took five years of pedal-to-the-metal policy by our own Federal Reserve before the American economy finally started to gather steam. In Europe, most of the troubles are structural (aging populations and rigid labor laws) and fiscal (nations hobbled by rigid labor laws that therefore can’t afford to support their aging populations) rather than monetary. Another problem in Europe is that regulators have made it so costly for banks to take risks by making small-business loans that small businesses are starved for credit. QE can’t fix that problem, either. But it can help drive the euro down, which will help the continent’s exporters and tourist industries, and it can help push stock prices up, which might encourage larger enterprises to raise capital and make acquisitions. So it is a decent start.

Two weeks earlier, in anticipation of the ECB move, the Swiss National Bank reneged on its prior public pronouncements and abandoned its policy of supporting the euro’s value against the Swiss franc. The franc appreciated by 40 percent within a matter of minutes. This created chaos for currency traders and serious financial problems for some firms that are heavily involved in the foreign exchange markets. It also hammered the stock prices of large Swiss companies that sell much of their production abroad, including watch maker Swatch. The abrupt reversal made some observers question whether market participants ought to trust the word of any central banker about plans or policy.

As the Swiss central bank noted, however, it was impractical to signal the policy change in advance. Traders would have rushed to sell as many euros as possible to the bank in order to get the artificially high price that prevailed while the Swiss were trying to suppress their own currency’s value. So it was tough luck for the forex trading crowd, and also for anyone arriving in Switzerland for last week’s World Economic Forum in Davos - where the price of just about everything, measured in non-Swiss currency, was suddenly a lot higher.

Although Switzerland punches well above its weight class in the global economy, the abrupt change in the franc’s value is not a big deal in the grand scheme of things. Switzerland gets respect, but it is no China.

Speaking of China, that country’s main stock market plunged last week when regulators abruptly slapped new limits on margin-based trading. The country’s economy is slowing and distortions are building in its financial sector. This is a big potential trouble spot. Cheaper oil will help, however, and so will a steadily appreciating U.S. dollar. It was not too long ago that China was accused of artificially depressing its currency’s value to gain a trade advantage. Now the yuan is weakening due to natural economic forces, and that weakness is good news for China’s crucial export sector.

China may benefit from lower oil prices even more than the United States, which has a substantial energy sector that is being forced to adjust. Here in the States, prices in many regions are now hovering at $2 or less for a gallon of unleaded regular. Benchmark prices for crude seem to have stabilized recently between about $45 and $48 per barrel, even after the death last week of Saudi Arabia’s King Abdullah. If this price range holds, the energy sector will retrench, but it will not crash, while the rest of the domestic economy benefits.

It is a lot to take in. As always there are cross-currents and factors that offset one another, but on balance the news is positive, and not just for the United States. True, we seem to be gaining economic traction faster than most other places. But a recovering America is a crucial driver of prosperity elsewhere. Our growth does not guarantee progress in other countries, but it can give such prosperity a jump start. The news in these opening weeks of 2015 may indicate that the cables are hooked up.

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