Germany and Deutsche Bank both face economic problems

One of the supposed constants of the credit crunch era has been the economic performance of Germany. Earlier this week saw a type of confirmation of past trends as the European Central Bank or ECB updated its capital key, which is calculated on the basis show below.

The shares of the NCBs in the ECB’s capital are weighted according to the share of the respective Member States in the total population and gross domestic product of the European Union (EU), in equal measure.

Few will be surprised to read that in Euro area terms ( other European Union members are ECB shareholders with the Bank of England at 14.33%) the share of Germany has risen for 25.6% to 26.4%. That poses an issue for any future ECB QE especially as the Italian share has declined. But a little food for thought is provided by the fact that the Bank of England share went up proportionately more.

The economic outlook

As the latest monthly economic report from the Bundesbank points out the situation is not starting from its usual strength.

Economic output in Germany dipped slightly in
the third quarter of 2018. According to the
Federal Statistical Office’s flash estimate, real
gross domestic product (GDP) contracted by
0.2% in seasonal and calendar-adjusted terms
as compared to the previous quarter.

That has tended to be swept under the carpet by the media partly because of this sort of analysis.

This decline was mainly caused by a strong temporary
one-off effect in the automotive sector.

Central banks always tell you a decline is temporary until they are forced not too and in this instance we see two bits at this particular cherry as “temporary” finds “one-off” added to it. But the detail begs a question.

Major problems in connection with the introduction
of a new EU-wide standard for measuring exhaust emissions led to significant production
stoppages and a steep drop in motor vehicle
exports.

Fair enough in itself but we know from our past analysis that production boomed ahead of this so we are counting the down but omitting the up. Whereas next we got something I had been suggesting was on the cards.

At the same time, private consumption was temporarily absent as an important force driving the economy.

This reminds me of my analysis from October 12th.

 Regular readers will be aware of the way that money supply growth has been fading in the Euro area over the past year or so, and thus will not be surprised to see official forecasts of a boom if not fading to dust being more sanguine.

The official view blames the automotive sector but if we take the estimate of that below we are left with economic growth of a mere 0.1%.

 IHS Markit estimates that the autos drag on Germany was around -0.3 ppts on GDP in Q3

Apparently that is a boom according to the Bundesbank as its view is that the economy marches on.

Despite these temporary one-off effects, the economic
boom in Germany continues.

Indeed we might permit ourselves a wry smile as the usual consensus that good weather boosts an economy gets dropped like a hot potato.

as well as the exceptionally hot, dry
weather during the summer months.

No ice-creams or suntan oil apparently.

What about now?

The official view is of a powerful rebound this quarter but the Markit PMI survey seems to be struggling to find that.

 If anything, the underlying growth trajectory for the industry remains downward: German manufacturers reported a near stagnation of output in November, the sharpest reduction in total new orders for four years and a fall in exports not seen since mid-2013. Moreover, Czech goods producers, who are sensitive to developments in the autos sector, again commented on major disruption,

If we look wider we see this.

The Composite Output Index slipped to a near four-year low of 52.3 in November, down from 53.4 in October.

Moving to this morning’s official data we were told this.

In October 2018, production in industry was down by 0.5% from the previous month on a price, seasonally and calendar adjusted basis according to provisional data of the Federal Statistical Office (Destatis).

It was 1.6% higher than a year ago on the other side of the coin but Bundesbank hopes of a surge in consumption do not seem to be shared by producers.

The production of consumer goods showed a decrease of 3.2%.

Yesterday’s manufacturing orders posed their own questions.

+0.3% on the previous month (price, seasonally and calendar adjusted)
-2.7% on the same month a year earlier (price and calendar adjusted)

Deutsche Bank

The vultures are circling again and here is how the Wall Street Journal summed it up yesterday.

Deutsche Bank shares were down about 4% in afternoon trading Thursday in Frankfurt, roughly in line with European banks amid broader market declines. Deutsche Bank shares have fallen 51% this year to all-time lows below €8 ($9.08).

As I type this it has failed to benefit much from today’s equity market bounce and is at 7.73 Euros. Perhaps because investors are worried that if it has not done well out of “the economic boom” then prospects during any slow down look decidedly dodgy. Also perhaps buyers are too busy laughing at the unintentional comedy here.

Deutsche Bank on Thursday and last week defended senior executives. Improving compliance and money-laundering controls “has been a real emphasis of current management,” and the bank has made “enormous investments” in fighting financial crime, said Mr. von Moltke, who joined the bank in 2017, in the CNBC interview.

Could it do any worse? The numbers are something of a riposte also to those like Kenneth Rogoff who blame cash and Bitcoin for financial crime.

Deutsche Bank processed an additional €31bn of questionable funds for Danske Bank than previously thought – that takes the total amount of money processed by the German lender for Danske’s tiny Estonian branch to €163bn ( Financial Times).

That compares to the present market value of 16 billion Euros for its shares. That poses more than a few questions for such a large bank and whilst banking sectors in general have been under pressure Deutsche Bank has been especially so. Personally I do not seem how merging it with Commerzbank would improve matters apart from putting a smoke screen over the figures for a year or two. One thing without doubt is that it would make the too big to fail issue even worse.

Comment

If we look at the broad sweep Germany has responded to the Euro area monetary slow down as we would have expected. What is less clear is what happens next? This quarter has not so far show the bounce back you might expect except in one area. The positive area is the labour market where employment is 1.2% higher than a year ago and wages have risen with some estimates around 3%. So the second half of 2018 seems set to be a relatively weak one.

One area which must be an issue is the role of the banks because as they, and Deutsche Bank especially, get weaker how can they support the economy via lending to businesses? At least with the fiscal position strong ( running a surplus) Germany has ammunition for further bailouts.

Moving back to the ECB I did say I would return to the capital key change. It means that under any future QE programme it would buy relatively more German bunds except with its bond yields so low with many negative it does not need it. Also should the slow down persist there is the issue of it being despite monetary policy being so easy.

 

 

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The problematic nature of current bond yields

One of the features of the credit crunch era has been the falls in first world interest-rates and bond yields. The first phase saw the slashing of official short-term interest-rates and once that was seen to be inadequate, central banks directly purchased bonds to reduce yields further. It is seldom put like this but there was already an implied failure as according to the models back then the interest-rate cuts should have done the trick. Back then I was already looking ahead to when there would have to be ch-ch-changes and posted the view that central banks would delay what has become called policy normalisation.

For example back on the 24th of February 2011 I pointed out this about a speech from David Miles of the Bank of England.

 My problem with this is that when you act as they have and you have in effect used what weapons the Bank of England has virtually to the maximum by cutting interest-rates by 4.75%% and spending some £200 billion on asset purchases then you have been extraordinarily interventionist. Accordingly it is then hard for you to blame events because some of them are the consequence of your own actions……

What that illustrates is that already the truth was being manipulated and also I am glad I wrote “virtually to the maximum” as of course the amount of asset purchases has more than doubled. In addition we have seen credit easing in the UK via such policies as the Term Funding Scheme and the start of full-scale QE from the European Central Bank as well as negative interest-rates.

But the point about delaying proved to be very accurate as the Euro area is still actively pursuing QE and in net terms the UK has managed to raise interest-rates by a measly 0.25%. The opportunity in 2014/15 was meant with promises via Forward Guidance but no action.

The US

This is the one country which has taken clear action on the path to normalisation. Here is the current state of play.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 2 to 2-1/4 percent.

That is currently working out be be around 2.2% and more rises are promised. Also there is some reversing of the QE or Qualitative Tightening.

The Committee directs the Desk to continue
rolling over at auction the amount of principal
payments from the Federal Reserve’s holdings
of Treasury securities maturing during each
calendar month that exceeds $30 billion, and to
continue reinvesting in agency mortgage-backed
securities the amount of principal
payments from the Federal Reserve’s holdings
of agency debt and agency mortgage-backed
securities received during each calendar month
that exceeds $20 billion.

That combined with forecasts of another interest-rate rise in a fortnight and at least a couple next year seemed to put pressure on bond markets. However this sentence in a speech from Federal Reserve Chair Jerome Powell shook things up on the 28th of last month and the emphasis is mine.

We therefore began to raise our policy rate gradually toward levels that are more normal in a healthy economy. Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy‑‑that is, neither speeding up nor slowing down growth.

You may note we seem to have travelled from “policy normalisation” to neutral. But what the neutral interest-rate represents is an attempt to figure out what interest-rate would neither stimulate or contract the economy. Or a sort of measure of what we might aim for as a new normal. When they are trying to put a pseudo scientific gloss on things economist and central bankers call it r-squared.

However the “just below” dropped the expected path for US interest-rates by 0.5%.

Bond Markets

Let me take you to the Wall Street Journal on Tuesday.

This quarter, yields on longer-dated bonds have dropped and those on two-year Treasurys are flat. The gap between two and 10-year Treasury yields is now around 0.11 percentage point, compared with around 0.55 percentage point at the beginning of the year.

This is attracting a lot of attention in the financial media but the change of 0.44% is pretty much my 0.5% suggestion above. Now let us look at the US ten-year yield which is 2.9% as I type this and we see that in basic terms it is predicting a couple more 0.25% interest-rate rises. This will come in the next year or so if true so it is not very different to the two-year yield of 2.76%.

If we look beyond Federal Reserve policy we have seen a fall in the price of oil over the past month or two. If we look at it in Brent Crude terms then just above US $86 of early October has been replaced by below US $59 this morning as oil follows equity markets lower. The exact amount of the change varies but the path for inflation now seems set to be lower as it has been rare in 2018 for the oil price to be below where it was this time last year. That is another reason for lower bond yields.

Is this a signal of a recession? Here is the St.Louis Fed from last week.

Does the recent flattening of the yield curve portend recession? Not necessarily. The flattening of the real yield curve may simply reflect the fact that real consumption growth is not expected to accelerate or decelerate from the present growth rate of about 1 percent year over year. On the other hand, a 1 percent growth rate is substantially lower than the U.S. historical average of 2 percent. Because of this, the risk that a negative shock (of comparable magnitude to past shocks) sends the economy into technical recession is increased.

That is a fascinating way of looking at it and in my experience precisely zero bond market participants will look at it like that. It is also revealing that we seem to just assume growth will now be lower. Didn’t they save us?

Comment

I wanted to look at this subject today because of the clear changes which are happening. Now it looks much less likely that US interest-rates will pass 3% and if they do not by much. So “normalisation” will be at best about two-thirds of what it might have been considered to be pre credit crunch ( 4.5%). Some of you have suggested that we can no longer afford interest-rates and yields above 3% so well done at least if we stay where we are! If Italy folds you may get a second tick in that box.

But as we look wider we see even more extraordinary developments. Let me take a look at my own country the UK which is in political disarray yet the ten-year Gilt yield is below 1.3%. So those predicting a surge in Gilt yields are slipping back into the bushes whilst I note the extraordinary absolute level and the persistence of negative real yields which bust past metrics. Germany has a ten-year yield of 0.26% and a five-year one of -0.3% as we note again more metrics which are busted.

So my view is that we cannot rely on old recession metrics because another cause of all of this is that QE4 from the US Fed has got closer. I have worried all along that interest-rate rises might run into more QE and if they do we will be singing along to Coldplay.

Oh no I see
A spider web and it’s me in the middle
So I twist and turn
Here am I in my little bubble

 

 

The Bank of England and Mark Carney are in denial mode

One of the features of the Brexit debate has been the role of the Bank of England in it. One thing that a supposedly independent central bank should do is avoid being accused of being on one side or the other of political debates. Also it has presented a view which is supposedly supported by the whole institution when with such a split nation that seems incredibly implausible. Thus the alternative view of independence and the reason for having external members, which is to provide different perspectives and emphasis, looks troubled at best.

On this road we see an organisation where all the Deputy-Governors are alumni of Her Majesty’s Treasury, which raises the issue of establishment capture. Also this from the Bank of England website suggests the use of another form of motivation to capture individuals.

Dr Ben Broadbent became Deputy Governor on 1 July 2014. Prior to that, he was an external member of the Monetary Policy Committee from 1 June 2011.

I am far from alone in thinking that this sets up all the wrong motivations and strengthens the power of the Governor via patronage. As to appointment of the absent-minded professor maybe one day he will demonstrate why unless of course we already know.

For the decade prior to his appointment to the MPC, Dr Broadbent was Senior European Economist at Goldman Sachs,

Mervyn King

There is something of an irony in the way that any sort of flicker of Bank of England comes from the former Governor the now Baron King of Lothbury although Bloomberg describe him without his new title.

Mervyn King, a professor at the New York University Stern School of Business,

If we move to his critique here are the details.

It saddens me to see the Bank of England unnecessarily drawn into this project. The Bank’s latest worst-case scenario shows the cost of leaving without a deal exceeding 10 percent of GDP.

Why is this wrong?

Two factors are responsible for the size of this effect: first, the assertion that productivity will fall because of lower trade; second, the assumption that disruption at borders — queues of lorries and interminable customs checks — will continue year after year. Neither is plausible. On this I concur with Paul Krugman. He’s no friend of Brexit and believes that Britain would be better off inside the EU — but on the claim of lower productivity, he describes the Bank’s estimates as “black box numbers” that are “dubious” and “questionable.” And on the claim of semi-permanent dislocation, he just says, “Really?” I agree: The British civil service may not be perfect, but it surely isn’t as bad as that.

The productivity issue is one that has been addressed at the Treasury Select Committee ( TSC) this morning. As I listened I heard Deputy Governor Broadbent tell us that productivity has been falling which is true but when it came to a rationale for further Brexit driven effects we got only waffle. Actually the Chair of the TSC Nicky Morgan was much more impressive by discussing the oil price shock of the 1970s as opposed to Ben Broadbent’s New Zealand based example from the same decade. Later questions on this subject had both the Governor and Ben Broadbent in retreat on the issue of how useful an example New Zealand will be especially as it coincided with a large oil price shock.

There are different arguments as to how long any Brexit effect would last. However one would expect at least some of the issues to decline and go away.

Bank of England evidence

If we move to this morning;s questions posed to the Bank of England there has been a clear attempt by Governor Carney to cover off the fire he is under with two methodologies.

  1. To say the Treasury Select Committee asked for the production of scenarios.
  2. To present it as a technocratic and scientific process where we were told 160 people were involved and 600, measurements were taken. We were guided towards some elasticities where the range was presented between 0.75 and 0.16 and told that 0.25 had been chosen.

He has a point with the first issue because they did do that when it would have been better to have asked the Office for Budget Responsibility. After all as it has been drawn from the same establishment base it would have been likely to have given similar answers if that was the purpose and kept the Bank of England out of it. The second argument is very weak as anyone familiar with the methodology knows that economic models depend more on the assumptions used than anything else. You do not need to know much about them to realise that they are an art form much more than they are a science. Usually of course a bad art form.

Next up was Deputy Governor Jon Cunliffe who has spent a career at HM Treasury as well as this described from the Bank of England website.

Before joining the Bank, Jon was the UK Permanent Representative to the European Union, effective from 9 January 2012.

When quizzed on this he told us this was in the past but a mere ten minutes later he was boasting about his experience. Sadly the inconsistency remained unchallenged as did his assertion that the higher cost of doing financial services business in Frankfurt as opposed to London was not going to be a major factor.

The issue of making this accessible came up with an MP just asking “I am looking for human speak” which added to a previous request for Governor Carney to talk like a human being rather than like an economist. This did not go especially well and to my mind left the interventions of the absent-minded professor as mostly waffle.

Sadly this from the Governor was not challenged though.

We are delivering price stability

Since inflation has been above its 2% per annum target for 18 months that is open to quite a bit of debate! That is before we get to the deeper issue of a 2% inflation target not being the price stability but is spun as. Also if we reflect that reality then one may be troubled by the next bit.

We will deliver financial stability.

Comment

There is a fair bit to consider here and as ever I do my best to avoid the politics and cover what has been said as accurately as I can as there is no official transcript yet. But let me return to an issue I raised last Thursday about the scenario where the Bank of England raises Bank Rate to 5.5% and other interest-rates go even higher.

BOE informing the masses. Carney tells that its controversial projection of Bank Rate going up to 5.5% on disorderly Brexit is mechanistic – a calculation from “a sum of squared deviations of inflation from target and output from potential.” Capiche? ( @DavidRobinson2k )

Nobody seems to have told the “squared deviations” that we are dealing with people who have consistently ignored deviations in inflation above target. Apparently though this is a complete success.

Carney adds that there was “a simpler, less-successful time”, when the Bank only focused on inflation…and we know how that turned out [it led to the financial crisis!].

That’s why we now have a financial policy committee to guard the economy, and that’s why the banks are ready for Brexit, the governor explains: ( The Guardian )

 

 

What is going on at the Bank of England these days?

Yesterday saw the publication of Brexit forecasts from HM Treasury and the Bank of England. The former was always going to be politically driven but the Bank of England is supposed to be independent, although these days we have to ask independent of what? There is little sign of that to be seen. Let us take a look at the Bank of England scenarios.

The estimated paths for GDP, CPI inflation and unemployment in the Economic Partnership scenarios are
shown in Charts A, B and C. The range reflects the sensitivity to the key assumptions about the extent to
which trade barriers rise, and how rapidly uncertainty declines. GDP is between 1¼% and 3¾% lower than
the May 2016 trend by end-2023. Relative to the November 2018 Inflation Report projection, by end-2023 it is 1¾% higher in the Close scenario, and ¾% lower in the Less Close scenario.

After singing its own fingers last time around it is calling these scenarios rather than forecasts but pretty much everyone is ignoring that. The problem with this sort of thing is that you end up doing things the other way around. Frankly the answers are decided and then the assumptions are picked to get you there. We do know some things.

Productivity growth has slowed, sterling has depreciated and the increase in inflation has squeezed real incomes.

However really the most certainty we have is about the middle part of a lower UK Pound £ and even there the Bank of England seems to omit its own part ( Bank Rate cut and Sledgehammer QE ) in the fall. That caused the fall in real incomes as we see how policy affected the results.

If we move wider the Bank of England attracted fire from both sides as for example this is from the former Monetary Policy Committee member Andrew Sentance who is a remain supporter.

The reputation of economic forecasts has taken a bad blow today with both UK government and appearing to use forecasts to support political objectives. Let’s debate – which I strongly oppose – rationally without recourse to bogus forecasts.

Why would he think that?

Well take a look at this.

The estimated paths for GDP, CPI inflation and unemployment in the disruptive and disorderly scenarios
are shown in Charts A, B and C. GDP is between 7¾% and 10½% lower than the May 2016 trend by end 2023.
Relative to the November 2018 Inflation Report projection, GDP is between 4¾% and 7¾% lower by
end-2023. This is accompanied by a rise in unemployment to between 5¾% and 7½%. Inflation in these
scenarios then rises to between 4¼% and 6½%.

It is the latter point about inflation and a claimed implication of it I wish to subject to both analysis and number-crunching.

How would the Bank of England respond to higher inflation?

Here is the claimed response.

Monetary policy responds mechanically to balance deviations of inflation from target and output
relative to potential. Bank Rate rises to 5.5%.

Let us see how monetary policy last responded to an expected deviation of inflation above target to back this up.

This package comprises:  a 25 basis point cut in Bank Rate to 0.25%; a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10 billion of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion.

As you can see the mechanical response seems to be missing! Unless of course you count the mechanical response of the mind of Mark Carney as he panicked thinking the UK was going into recession. The other 8 either panicked too or meekly fell in line. The point is further highlighted if we look at the scenario assumed for the exchange-rate of the UK Pound £.

And as the sterling risk premium increases, sterling falls by 25%, in addition to the 9% it has already fallen
since the May 2016 Inflation Report.

Let us examine the reaction function. Let us say that the £ had fallen by 10% when the Bank of England took action then if it ” responds mechanically” we would expect this time around to see a 0.625% reduction in Bank Rate and some £150 billion of extra QE as well as another Term Funding Scheme bank subsidy of over £300 billion.

Instead we are expected to believe that the Bank of England would raise and not cut interest-rates and would do so by 4.75%! There is also an issue with the timing as the forward guidance of the Bank of England has been for Bank Rate rises for over 4 years now and we have had precisely 0.25% in net terms. So at the current rate of progress the interest-rate increases would be complete somewhere around the turn of the century.

Actually there is more because other interest-rates would go even higher it would appear.

Uncertainty about institutional credibility leads to a pronounced increase in risk premia on sterling
assets, including a 100bps increase in the term premium on gilts.

So an extra 1% on Gilt yields although this is only related to a particular piece of theory as we skip what they would be apart from an implication of maybe 6.5%. A particular catch in that is the current ten-year yield is a mere 1.33% and over the past 24 hours it has been falling adding to the previous falls I have been reporting for a while now. Markets do of course move in the wrong direction at times but Gilt investors seem to be placing their bets on the Gilt market and ignoring the Bank of England scenario.

But wait there is more.

Overall, interest rates on loans to households and businesses rise by 250bps more than Bank Rate.

Can this sort of thing happen? Yes as we saw it in the build up to the credit crunch as UK interest-rates disconnected from Bank Rate by around 2%. Also yesterday we were noting such a thing via the fact that Unicredit of Italy has found itself paying 7.83% on a bond which was yielding only 1% as recently as yesterday. But there are two main problems of which the first occurred on Mark Carney’s watch as we note that they way he “responds mechanically” to such developments is to sing along with MARRS.

Pump up the volume
Pump up the volume
Pump up the volume
Get down

Actually such a response by the Bank of England was typical before the advent of Governor Carney. Recall this?

For instance, during the financial crisis the exchange rate
depreciated around 30% initially but settled to be around 25% below its pre-crisis peak in the following
couple of years.

So in a broad sweep in line with the new worst case scenario especially as we recall that inflation went above 5% on both main measures. So Bank Rate went to 5.5%? Er now it was slashed by over 4% to 0.5% and we saw the advent of QE that eventually rose in that phase to £375 billion.

Comment

The first comment was provided by financial markets as we have already noted the Gilt market rally which was accompanied by the UK Pound £ rallying above US $1.28. The UK FTSE 100 did fall but only by 13 points. If there is anything a Bank of England Governor would hate it is being ignored.

Actually the timing was bad too. For some reason the report was delayed from 7:30 am to 4:30 pm but due to yet another problem it was another ten minutes late. This means that very quickly eyes turned to this by Federal Reserve Chair Jerome Powell.

Stocks ripped higher on Wednesday after Federal Reserve Chairman Jerome Powell said interest rates are close to neutral, a change in tone from remarks the central bank chief made nearly two months ago. ( CNBC )

Roughly that seems to take 0.5% off the expected path of US interest-rates and has led to the US ten-year Treasury Note yield falling back to 3%. Also trying to convince people about higher inflation is not so easy when the oil price ( WTI) falls below US $50.

Me on Core Finance TV

 

 

 

 

 

The challenge for the ECB remains Italy and its banks

This week has seen something of an expected shifting of the sands from the European Central Bank ( ECB) about the economic prospects for the Euro area. On Monday its President Mario Draghi told the European Parliament this.

The data that have become available since my last visit in September have been somewhat weaker than expected. Euro area GDP grew by 0.2% in the third quarter. This follows growth of 0.4% in both the first and second quarter of 2018. The loss in growth momentum mainly reflects weaker trade growth, but also some country and sector-specific factors.

What he did not say was that back in 2017 quarterly growth had risen to 0.7% for a time. Back then the situation was a happy one for Mario and his colleagues as their extraordinary monetary policies looked like they were bearing some fruit. However the challenge was always what happens when they begin to close the tap? Let me illustrate things by looking again at his speech.

The unemployment rate declined to 8.1% in September 2018, which is the lowest level observed since late 2008, and employment continued to increase in the third quarter…….. Wages are rising as labour markets continue to improve and labour supply shortages become increasingly binding in some countries.

There is a ying and yang here because whilst we should all welcome the improvement in the unemployment rate, we would expect the falls to slow and maybe stop in line with the reduced economic growth rate. So is around 8% it for the unemployment rate even after negative interest-rates ( still -0.4%) and a balance sheet now over 4.6 trillion Euros? That seems implied to some extent in talk of “labour supply shortages” when the unemployment rate is around double that of the US and UK and treble that of Japan. This returns us to the fear that the long-term unemployment in some of the Euro area is effectively permanent something we looked at during the crisis. In another form another ECB policymaker has suggested that.

I will focus my remarks today on the economies of central, eastern and south-eastern Europe (CESEE), covering both those that are already part of the European Union (EU) and those that are EU candidate countries or potential candidates………..Clearly, for most countries, convergence towards the EU-28 average has practically stalled since the outbreak of the financial crisis in 2008

Care is needed as only some of these countries are in the Euro but of course some of the others should be converging due to the application process. Even Benoit Coeure admits this.

And if there is no credible prospect of lower-income countries catching up soon, there is a risk that people living in those countries begin questioning the very benefits of membership of the EU or the currency union.

I have a couple of thoughts for you. Firstly Lithuania has done relatively well but the fact I have friends from there highlights how many are in London leading to the thought that how much has that development aided its economy? You may need to probe a little as due to the fact it was part of Russia back in the day some prefer to say they are Russian. Also the data reminds us of how poor that area that was once called Yugoslavia remains. It is hardly going to be helped by the development described below by Balkan Insight.

At the fifth joint meeting of the governments of Albania and Kosovo in Peja, in Kosovo, the Albanian Prime Minister Edi Rama backed the decision of the Kosovo government to raise the tax on imports from Serbia and Bosnia from 10 to 100 per cent.

Banks

Here the ECB is conflicted. Like all central banks its priority is “the precious” otherwise known as the banks. Yet it is part of the operation to apply pressure on Italy and take a look at this development.

As this is very significant let us break it down and yes in the world of negative interest-rates and expanded central bank balance sheets Unicredit has just paid an eye-watering 7.83% on some bonds. Just the 6.83% higher than at the opening of 2018 and imagine if you held similar bonds with it. Ouch! Of that there is an element driven by changes in Italy’s situation but the additional part added by Unicredit seems to be around 3.5%.

If we look back I recall describing Unicredit as a zombie bank on Sky News around 7 years ago. The official view in more recent times is that it has been a success story in the way it has dealt with non performing loans and the like. Although of course success is a relative term with a share price of 11.5 Euros as opposed to the previous peak of more like 370 Euros. Now it is paying nearly 8% for its debt we need not only to question even that heavily depreciated share price and it gives a pretty dreadful implied view for the weaker Italian banks such as Monte Paschi which Johannes mentions. Also those non-performing loans which were packaged up and sold at what we were told “great deals” whereas now they look dreadful, well on the long side anyway.

Perhaps this was what the Bank of Italy meant by this.

The fall in prices for Italian government securities has caused a reduction in capital reserves and
liquidity and an increase in the cost of wholesale funding. The sharp decline in bank share prices has resulted
in a marked increase in the cost of equity. Should the tensions on the sovereign debt market be protracted, the
repercussions for banks could be significant, especially for some small and medium-sized banks.

Comment

We can bring things right up to date with this morning’s money supply data.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, stood at 6.8% in October, unchanged from previous month.

So we are holding station to some extent although in real terms we are slightly lower as inflation has picked up to 2.2%. Thus the near-term outlook remains weak and we can expect a similar fourth quarter to the third. Actually I would not be surprised if it was slightly better but still weak..

Looking around a couple of years ahead the position is slightly better although we do not know yet how much of this well be inflation as opposed to growth.

Annual growth rate of broad monetary aggregate M3 increased to 3.9% in October 2018 from 3.6% in September (revised from 3.5%).

On the other side of the coin credit flows to businesses seem to have tightened.

Annual growth rate of adjusted loans to non-financial corporations decreased to 3.9% in October from 4.3% in September

Personally I think that the latter number is a lagging indicator but the ECB has trumpeted it as more of a leading one so let’s see.

The external factor which is currently in play is the lower oil price which will soon begin to give a boost and will reduce inflation if it remains near US $60 for the Brent Crude benchmark. But none the less the midnight oil will be burning at the ECB as it mulls the possibility that all that balance sheet expansion and negative interest-rates gave economic activity such a welcome but relatively small boost. Also it will be on action stations about the Italian banking sector. For myself I fear what this new squeeze on Italian banks will do to the lending to the wider economy which of course had ground to a halt as it is.

 

Where next for the world of Bitcoin?

The world of Bitcoin and indeed all the other altcoins has seen quite a reversal as 2018 has progressed. The days of “free money” have gone and they have been replaced by this according to MarketWatch.

Bitcoin is breaking all sorts of records at the moment, most of them unwanted, and in a few days it will equal a milestone not matched in four years.

Not since October of 2014 has the price of bitcoin   seen four consecutive monthly declines, and a negative close for the month of November, which now seems a foregone conclusion, would match this feat having fallen every month since August, according to Dow Jones Market Data.

So a clear change although in the fast moving world of Bitcoin it is still over ten times higher than it was back then. If anything the fall seems to be picking up the pace.

After opening November above $6,500, bitcoin is down more than 40%, and since the four-month streak began on Aug. 1, the value of the world’s most famous digital currency has more than halved.

As I type this the Bitcoin price is at US $3763.7 which is down some US $282 or a bit under 7%. I note that just to add to the confusion there is also now a Bitcoin Cash. This was created by a fork out of Bitcoin.

Bitcoin cash was one of the marvels of the bitcoin bubble. It is a fork from bitcoin. A fork of a cryptocurrency takes place when someone, anyone declares that a blockchain is going to be transferred to a new set of rules and network infrastructure. ( Forbes)

It did lead to what was free money for a while.

When the fork came out, bitcoin did not fall and bitcoin cash went through the roof rising from the low hundreds to shoot quickly above $1,000. It was free money for bitcoin holders who could get their hands on their bitcoin cash by navigating the technical issues, which were mighty. ( Forbes)

But the gains were short-lived.

The central bankers revenge

From a central banking point of view the altcoin world is a disaster as they have no power to set interest-rates and no control over the total amount of it. Even worse it bypasses “the previous” and in the bull market days saw very heavy disinflation as the price of goods and services became much cheaper. At the limit it would make them be an anachronism and then irrelevant.

John Lewis of the Bank of England put it like this on the 13th of this month.

Existing private cryptocurrencies do not seriously threaten traditional monies because they are afflicted by multiple internal contradictions. They are hard to scale, are expensive to store, cumbersome to maintain, tricky for holders to liquidate, almost worthless in theory, and boxed in by their anonymity. And if newer cryptocurrencies ever emerge to solve these problems, that’s additional downside news for the value of existing ones.

There are of course issues there but being “almost worthless in theory” is a critique that could be pointed at central bank fiat currencies which also rely on an act of faith to have value. Also the bit about new companies would have applied to the proliferation of railway companies back in the day. Whereas we know that whilst many failed the railways are still with us. Those suffering commuters who use Southern Rail may wish that they didn’t but they do.

Let us look at his paradoxes or as he might have put it seven deadly sins.

The congestion paradox

But cryptocurrency platforms are different. Their costs are largely variable, their capacity is largely fixed. Like the London Underground in rush hour, crypto platforms are vulnerable to congestion: more patrons makes them *less* attractive.

The storage paradox

Each user has to maintain their own copy of the entire transactions history, so an N-fold increase in users and transactions, means an N-squared fold increase in aggregate storage needs.

The mining paradox

Rewarding miners with new units of currency for processing transactions leads to a tension between users and miners.  This crystalises in Bitcoin’s conflict over how many transactions can be processed in a block. Miners want this kept small………But users want the exact opposite: higher capacity, lower transactions costs and more liquidity, and so favour larger block sizes.

The concentration paradox

This starts in intriguing fashion.

 97% of bitcoin is estimated to be held by just 4% of addresses, and inequality rises with each block.

However this critique is also applicable to the central banking enthusiasm for higher house prices and the “wealth effects”

An asset is valued by the market price at which it changes hands. Only a fraction of the stock is actually traded at any point in time. So the price reflects the views of the marginal market participant.

You can’t all sell at once and certainly not at that price. The list below is somewhat breathtaking in the circumstances.

But for cryptos they are much larger because i)Exchanges are illiquid ii) Some players are vast relative to the market iii) There isn’t a natural balance of buyers and sellers iv) opinion is more volatile and polarised.

As central banks have sucked liquidity of out markets with their actions, for example the Japanese government bond market has often been frozen, the opening point is a bit rich. Ditto point ii) if we look at the size of central bank balance sheets and of course there was no natural balance between buyers and sellers when they surged into markets. For example some of the recent turmoil in the Italian government bond market has been caused by the “unnatural” buying of the ECB being reduced. As to the last point, well maybe, but so many things are polarised these days.

The valuation paradox

The puzzle in economic theory is why private cryptocurrencies have any value at all.

Fiat currencies anyone?

The anonymity paradox

The (greater) anonymity which cryptocurrencies offer is generally a weakness not a strength. True, it creates a core transactions demand from money launderers , tax evaders and purveyors of illicit goods> because they make funds and transactors hard to trace.

This is both true and an attempted smear. After all the recent money laundering spree undertaken in the Baltics by customers of Danske Bank seems to have been at 200 billion Euros or so much larger than the altcoin universe in total.

Of course for a central banker it needs central bankers.

 Keep a cryptocurrency far from regulated institutions and you reduce its value, because it drastically restricts the pool of willing transactors and transactions. Bring it closer to the realm of regulated financial institutions and it increases in value.

The innovation paradox

Perhaps the biggest irony of all is that the more optimistic you are about tomorrow’s cryptocurrencies, the more pessimistic you must be about the value of today’s.

Odd though that this sort of logic is not applied to forward guidance.

Expect it to be worthless in the future, and it becomes worthless now.

Comment

There is a lot to consider here and let me start by offering some sympathy for those who did this back in the day. From CNBC.

Bitcoin is in the “mania” phase, with some people even borrowing money to get in on the action, regulator Joseph Borg said. “We’ve seen mortgages being taken out to buy bitcoin. … People do credit cards, equity lines,” he said. Bitcoin has been soaring all year, starting out at $1,000 and rocketing above $19,000 on the Coinbase exchange last week. ( CNBC )

Hard to believe that was the 11th of December last year as it feels like a lifetime ago. Also yes I do feel sorry for them even though it was pretty stupid. A fortnight or so earlier we were looking at some of the issues above.

That statement is true of pretty much every price although of course some have backing via assets or demand. So often we see a marginal price used to calculate a total based on an average price that is not known………This leaves us with the issue of how Bitcoin functions as a store of money which depends on time. Today’s volatility shows that over a 24 hour period it clearly fails and yet if we extend the time period so far at least it has worked rather well as one.

As to the store of value function that still holds as early buyers have still done really rather well but more recent ones have taken a bath and a cold one at that. Looking ahead it does not look as though the market has capitulated enough to find the ground to rally, But in the background there are still flickers of good news.

Ohio appears set to become the first state to accept bitcoin for tax bills, a show of support for a technology that has garnered lots of hype but failed to gain traction as a form of payment. ( WSJ)

 

Mario Draghi and the ECB prepare for a change of course next month

After a week where the UK has dominated the headlines it is time to switch to the Euro area.  This is for two reasons.  We receive the latest inflation data but also because a speech from European Central Bank President Mario Draghi has addressed an issue we have been watching as 2018 has developed. We have been waiting to see how he and it will respond to the economic slow down that is apparent. This is especially important as during the credit crunch era the ECB has not only been the first responder to any economic downturns it has also regularly found itself to be the only one. Thus it finds itself in a position whereby in terms of negative interest-rates ( deposit rate of -0.4%) and balance sheet ( still expanding at 15 billion Euros per month ) and credit easing still heavily deployed. Accordingly this sentence from Mario echoes what we have been discussing for quite a while.

The key issue at stake is as follows: are we witnessing a temporary “soft patch” or a more lasting deterioration in the growth outlook?

The latter would be somewhat devastating for the man who was ready to do “whatever it takes” to save the Euro as it would return us to discussions about its problems a major one of has been slow economic growth.

Some rhetoric

It seems to be a feature these days of official speeches that they open with what in basketball terms would be called a head fake. Prime Minister Theresa May did it yesterday with an opening sentence which could have been followed by a resignation and Mario opened with what could have been about “broad based” economic growth.

The euro area economy has now been growing for five years, and we expect the expansion to continue in the coming years.

Of course central bankers always expect the latter until there is no other choice. Indeed he confirms that line of thought later.

There is certainly no reason why the expansion in the euro area should abruptly come to an end.

As we move on we get an interesting perspective on the past as well as a comparison with the United States.

Since 1975 there have been five periods of rising GDP in the euro area. The average duration from trough to peak is 31 quarters, with GDP increasing by 21% over that period. The current expansion in the euro area, however, has lasted just 22 quarters and GDP is only around 10% above the trough. In contrast, the expansion in the United States has lasted 37 quarters, and GDP has risen by 21%.

The obvious point is whether you can use the Euro area as a concept before it even existed?! Added to that via the “convergence” promised by the Euro area founders economic growth should be better now than then, except of course we have seen plenty of divergence too. Also you might find it odd to be pointing out that the US has done better especially as the way it is put which reminds us that for all the extraordinary monetary action the Euro area has only grown by 10%. Even that relies on something of a swinging ball as of course he is comparing with the bottom of the dip rather than the past peak as otherwise the number would be a fair bit weaker. Mario is leaving a bit of a trap here, however, or to be more precise he thinks he is.

How have we got here?

First we open with two standard replies the first is that whilst any growth is permanent setbacks are temporary and the other fallback is to blame the weather.

The first is one-off factors, which have clearly played an important role in the underperformance of growth since the start of the year. In the first half of 2018, weather, sickness and industrial action affected output in a number of countries.

Actually that makes the third quarter look even worse as they had gone by then yet growth slowed. He is on safer ground here though.

Production slowed as carmakers tried to avoid building up inventory of untested models, which weighed heavily on economies with large automobile sectors, such as Germany. Indeed, the German economy actually contracted in the third quarter, removing at least 0.1 percentage points from quarterly euro area growth.

This is another marker being put down because it you are thinking that you might need to further expand monetary policy it is best to try to get the Germans onside and reminding them that they too have issues will help. Indeed for those who believe that ECB policy is essentially set for Germany it may be not far off a clincher.

There is something that may worry German car producers if they are followers of ECB euphemisms.

The latest data already show production normalising.

After all the ECB itself may not achieve that.

Trade

This paragraph is interesting on quite a few levels.

The second source of the slowdown has been weaker trade growth, which is broader-based. Net exports contributed 1.4 percentage points to euro area growth in 2017, while so far this year they have removed 0.2 percentage points. World trade growth decelerated from 5.2% in 2017 to 4.6% in the first half of this year.

Oddly Mario then converts a slow down in growth to this.

We are witnessing a long-term slowdown in world trade.

As we note the change in the impact of trade on the Euro area there are several factors in play. You could argue that 2017 was a victory for the “internal competitiveness” austerity model applied although when we get to the collective that is awkward as the Euro area runs a large surplus driven by Germany. From the point of view of the rest of the world they would like it to reduce although the preferable route would be for the Euro area ( Germany ) to import more.

Employment

Mario cheers rightly for this.

Over the past five years, employment has increased by 9.5 million people, rising by 2.6 million in Germany, 2.1 million in Spain, 1 million in France and 1 million in Italy.

I bet he enjoyed the last bit especially! But later there is a catch which provides food for thought.

 But since 2013 more than 70% of employment growth has come from those aged 55-74. This partly reflects the impact of past structural reforms, such as to pension systems.

Probably not the ECB pension though as we are reminded of “Us and Them” by Pink Floyd.

Forward he cried from the rear
And the front rank died
And the general sat
And the lines on the map
Moved from side to side.

Also whilst no doubt some of these women wanted to work there will be others who had no choice.

The share of women in work has also risen by more than 10 percentage points since the start of EMU to almost 60% – its highest level ever

Put another way this sentence below could fit into a section concerning the productivity crisis.

 In addition, countries that have implemented structural reforms have in general seen a rise in labour demand in recent years compared with the pre-crisis period. Germany, Portugal and Spain are all good examples.

There is a section on wages but Mario end up taking something of an each-way bet on this.

But in the light of the lags between wages and prices after a period of low inflation, patience and persistence in our monetary policy is still needed.

Money Supply and Credit

This is how central bankers report a sustained and considerable slow down in the money supply.

The cost of bank borrowing for firms fell to record lows in the first half of this year across all large euro area economies, while the growth of loans to firms stood at its highest rate since 2012. The growth rate of loans to households is also the strongest since 2012, with consumer credit now acting as the most dynamic component, reflecting the ongoing strength of consumption.

Also the emphasis below is mine and regular readers are permitted a wry smile.

Household net worth remains at solid levels on the back of rising house prices and is adding to continued consumption growth.

Comment

We are being warmed up for something of a change of course in case it is necessary.

When the Governing Council met in October, we confirmed our confidence in the economic outlook………….When the latest round of projections is available at our next meeting in December, we will be better placed to make a full assessment of the risks to growth and inflation.

As if they are not already thinking along those lines! The next bit is duo fold. It reminds us that the Euro area has abandoned fiscal policy but does have a kicker for the future.

To protect their households and firms from rising interest rates, high-debt countries should not increase their debt even further and all countries should respect the rules of the Union.

The kicker is perhaps a hint that there is a solution to that as well.

In conclusion, I want to emphasise how completing Economic and Monetary Union has become more urgent over time not less urgent – and not only for the economic reasoning that has always underpinned my remarks, but also to preserve our European construction………….more Europe is the answer.

There Mario leaps out of his apparent trap singing along to Luther Vandross.

I just don’t wanna stop
Oh my love, a million days in your arms
Is never too much (never too much, never too much, never too much)

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