By Matthew W. Lynn
The Telegraph, London
Wednesday, July 20, 2016
http://www.telegraph.co.uk/business/2016/07/2...-must-realis...
Would you feel comfortable lending money to the mining conglomerate
Glencore, a company that only last year came perilously close to imploding?
Or Telecom Italia, with its massive exposure to the weakest major economy in
the world? Or to Lufthansa, a lumbering beast of an airline just waiting to
be eaten alive by new and aggressive low-cost carriers?
Well, perhaps you would, and perhaps you wouldn't. If you are part of the
eurozone, however, you don't have any choice.
This week we learned that the European Central Bank (ECB) has been buying
bonds in all those companies as part of its latest round of quantitative
easing. It is far from alone in pumping money directly into corporations.
Over the last few years, the Bank of Japan has been buying equities so
furiously it is now one of the biggest stakeholders in Japan Inc. All it will
take is one downturn, and it would be no surprise if the Bank of England and
the Federal Reserve followed suit.
But is that really wise? Central banks, which are owned by the state, are
going to end up controlling huge swathes of private industry. That is sold as
a way of stimulating growth. But it could end up as nationalisation by the
back door -- and everything we know about economic history tells us that
always ends in disaster.
Having exhausted just about every other way of stimulating some life into
the moribund eurozone economy, the ECB has now resorted to pumping cash
directly into the corporate sector. It tried loading the banks up with cash,
but they are so reluctant to lend it out that the ECB has now started buying
corporate bonds instead. It is currently doing so at a rate of 300 million
euros a day -- serious money even for the ECB.
Earlier this week it published details of what it has been buying. Most of
the major eurozone corporations are there. So are companies from elsewhere,
which are eligible so long as the debt is issued through a unit within the
euro area. Such is the scale of the programme that prices are dropping and it
is getting a lot easier for big corporations to tap the markets for money.
The ECB is far from alone. The Bank of Japan has been buying equities on a
massive scale for several years now. It is now a Top 10 shareholder in 90 percent
of the companies listed on the Nikkei 225. It is a Top 10 holder of Fast
Clothing, which owns the Uniqlo chain, and a Top 3 holder of Yamaha, one of
the world's biggest instrument makers.
Plenty of economists will tell you that is simply a clever way of
stimulating the economy when interest rates are already zero. The trouble is
this, however. Even though the central banks claim they will be completely
neutral with their holdings, it is hard to see how that can be true. In fact,
there are two problems.
First, what happens in a crisis? Some of the bonds come with what the
market makers call “event risk,” and the rest of us would describe as
“terrible stuff about to happen at any moment."
For example, the ECB now owns bonds in Volkswagen. As we know, the German
car maker is still embroiled in a scandal over cheating on diesel emissions.
Where will that end up, and can the business withstand the potential legal
costs? No one yet knows. But one thing is clear. If it runs into serious
trouble, then the bondholders will end up taking control. And yet the ECB has
no mandate to get involved in sorting out VW or any other company.
Next, surely the ECB's choice of purchases is a form of intervention. If
it buys a Lufthansa bond, it lowers the cost of capital for that company.
That gives it an advantage over its rivals -- say, another EU-based airline
such as Ryanair. In many industries, such as airlines or utilities, cheap
capital is one of the most crucial factors in whether the business is a
success or not.
Whether it likes it or not, the ECB is favouring one or another. Even
worse, over time it opens up the bank to cronyism. How long before French or
Italian politicians demand that some tottering conglomerate be propped up
with cheap cash? It will probably happen before Christmas.
State control of the economy has always been a bad idea. It distorts the
playing field, favours political lobbying over competitive excellence, and
stops the market from allowing the best-managed businesses with the best
products to flourish. Central banks are pushing it through the back door.
They argue they are doing so to help revive demand and keep the economy
alive. But as with so many of their recent innovations, from zero rates to
printing money, the medicine is starting to look a lot worse than the
disease.
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