What more can the ECB do for the Euro?

Yesterday in something of a set piece event the new ECB President Christine Lagarde got out her pen to sign some banknotes and in the midst of her soaring rhetoric there were some interesting numbers.

In the euro area, banknotes are used for retail transactions more than any other means of payment. Some 79% of all transactions are carried out using cash, amounting to more than half of the total value of all payments.

So cash may no longer be king but it is still an important part of the Euro area economy. Indeed the numbers below suggest it may be an increasingly important part, perhaps driven by the fact that 0% is indeed better than the -0.5% deposit rate of the ECB.

And since their introduction, the number of euro banknotes in circulation has risen steadily, reflecting both the importance of cash in our economy and the euro’s international appeal. There are now 23 billion euro banknotes in circulation with a value of €1.26 trillion – a third of which are being used outside the euro area.

The latter reflection on use outside the Euro area is a rise because if we look elsewhere on the ECB website we are told this.

It is estimated that, in terms of value, between 20% and 25% of the euro banknotes in circulation are held outside the euro area, mainly in the neighbouring countries. The demand for euro banknotes rose steeply particularly in non-EU countries in eastern Europe when the financial crisis erupted in 2008 and national currencies depreciated against the euro.

We can figure out what was going on there as we recall the carry trade leading to mortgages and business borrowing being undertaken in Euros ( and Swiss Francs) in Eastern Europe. I guess that left some with a taste for the adventures of Stevie V.

Money talks, mmm-hmm-hmm, money talks
Dirty cash I want you, dirty cash I need you, woh-oh
Money talks, money talks
Dirty cash I want you, dirty cash I need you, woh-oh

I am not sure as to why the foreign holdings have risen so much. Some will no doubt cheer lead saying it is a sign of Euro acceptance and strength but there is the issue of notes being potentially used by money launderers and drug smugglers. The ECB is supposed to be against such criminal activity and has used that reason in its ending of production of 500 Euro notes.The circulation of them is in a gentle decline and there are now 458 million of them. The numbers of 200 Euro notes has shot higher as there were 253 million a year ago as opposed to 366 million ( and rising) now.

I did ask the ECB and they pointed me towards this.

Euro cash holdings are widespread in Albania, Croatia, the Czech Republic, the Republic of North Macedonia and Serbia. In those five countries, an average of 36% of respondents reported holding euro cash……..

That still leaves a fair bit unanswered.

Money Supply

There was some good news for the Euro area economic outlook earlier from this.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, increased to 8.4% in October from 7.9% in September.

Here we are adding some electronic money to the cash above and we can see that the upwards trend seen in 2019 has been reinstated after last month’s dip. Or if you prefer we have returned to August!

This gives an explanation of how the services sector has held up as the trade war has hit manufacturing. According to the Markit PMI surveys this is especially true in France.

Service sector growth continued to run at one of the highest
recorded over the past year.

The Euro area and the ECB should be grateful for this as according to Matkit even with the monetary growth things in this quarter are weak.

“The eurozone economy remained becalmed for a
third successive month in November, with the
lacklustre PMI indicative of GDP growing at a
quarterly rate of just 0.1%, down from 0.2% in the
third quarter.”

If we switch to the longer-term outlook we see this.

The annual growth rate of the broad monetary aggregate M3 stood at 5.6% in October 2019, unchanged from the previous month, averaging 5.6% in the three months up to October.

I think we get the idea that it is 5.6%! Anyway as we know M1 rose the wider sectors must have fallen.

The annual growth rate of short-term deposits other than overnight deposits (M2-M1) decreased to 0.6% in October from 1.2% in September. The annual growth rate of marketable instruments (M3-M2) was -2.4% in October, compared with -1.1% in September.

The growth rate of 5.6% suggests a better economic outlook for 2021 and head but there is a catch which is this.

 net external assets contributed 3.0 percentage points (up from 2.8 percentage points)

The external influence has been growing over the past year or so and if we subtract it then broad money growth is a mere 2.6% and flashing a warning.

Official Surveys

Today’s releases were upbeat.

In November 2019, the Economic Sentiment Indicator (ESI) increased slightly in both the euro area (by 0.5 points to
101.3) and the EU (by 0.9 points to 100.0)……Amongst the largest euro-area economies, the ESI increased in Spain (+0.7), France and Germany (both by +0.4), while it remained virtually unchanged in Italy (-0.1) and worsened in the Netherlands (−1.0).

However there was another sign of trouble,trouble,trouble for manufacturing.

According to the bi-annual investment survey carried out in October/November this year, real investment in the
manufacturing industry in 2019 is expected to decrease by 2% in both the euro area and the EU. Compared to the
previous survey conducted in March/April this year, this represents a downward revision by 6 and 5 percentage
points for the euro area and the EU, respectively. For 2020, managers expect an increase in real investment by 1%
in both regions.

Care is needed with this series though because if you believed it wholesale Germany would be having a good year economically.

Comment

The ECB finds itself at something of a crossroads.Some elements here are simple as with a weak economy and blow target inflation then its policy easing looks justified.It does not seem to have many monetarists on board but it could easily argue that monetary growth is supporting the economy.

The more difficult elements come from how quickly it had to ease policy again as the ceasefire only lasted around ten months. This then brings into focus the question of why economic growth has been so weak? One way it is trying to answer this is provided by the way it has replaced someone who sometimes behaved like a politician with an actual one which suggests a bigger effort in this area.

“Countries with fiscal space should use it quickly, even more so when they suffer an asymmetric shock like Germany,” Villeroy told the Europlace international forum in Tokyo. “Those with high public debt should make their public finances more growth-friendly. ( Reuters)

Some of this is more French trolling of Germany but France has been more in favour of fiscal policy all along. As a side-effect by providing more bunds for the ECB to buy more fiscal policy from Germany would allow another expansion of monetary policy.

That leaves us with a curiosity that may become the equivalent of a singularity. Central banks have failed in the credit crunch era yet their importance rises and especially in the Euro area they seem to feel it is their role to dictate to politicians,

 

 

 

Christine Lagarde trolls Germany and asks for more fiscal stimulus

This morning has seen the first set piece speech of the new ECB President Christine Lagarde and it would not be her without some empty rhetoric.

The idea of European renewal may, for some, elicit feelings of cynicism. We have heard it many times before: “Europe is at a crossroads”; “now is Europe’s moment”. Often that has not proven to be the case. But this time does in fact seem different.

To her perhaps, just like the Greek bailout was “shock and awe” which I suppose in the end it was just as a doppelganger of what she meant.

We also got some trolling of Germany.

Ongoing trade tensions and geopolitical uncertainties are contributing to a slowdown in world trade growth, which has more than halved since last year. This has in turn depressed global growth to its lowest level since the great financial crisis.

These uncertainties have proven to be more persistent than expected, and this is clearly impacting on the euro area. Growth is expected to be 1.1% this year, i.e. 0.7 percentage points lower than we projected a year ago

A lot of the reduction and impact has been on Germany but what Christine does not say is that this has become a regular Euro area issue where economic growth has been downgraded or poor or both. Briefly around 2017 we had the Euro boom but that required the monetary taps to be wide open. Missing here in the analysis is the fact that the stimulus was withdrawn into a growth slowdown.

Did I say there was some trolling of Germany?

At the same time, there are also changes of a more structural nature. We are starting to see a global shift – driven mainly by emerging markets – from external demand to domestic demand, from investment to consumption and from manufacturing to services.

Then we move onto rhetoric that is simply misleading.

The answer lies in converting the world’s second largest economy into one that is open to the world but confident in itself – an economy that makes full use of Europe’s potential to unleash higher rates of domestic demand and long-term growth.

She is setting policy for the Euro area and not Europe and the ECB itself tells us this about the Euro area.

Compared with its individual member countries, the euro area is a large and much more closed economy. In terms of its share of global GDP, it is the world’s third-largest economy, after the United States and China.

Economics

It is revealing that the next section was titled “resilience and rebalancing” words which these days send a bit of a chill down the spine. This chill continues as we see a call for this.

And when global growth falls, stronger internal demand can help protect jobs, too. This is because domestic demand is linked more to services – which are more labour-intensive – while external demand is linked more to manufacturing, which is less labour-intensive.

We are seeing that shield in action in the euro area today: the resilience of services is the key reason why employment has not yet been affected by the global manufacturing slowdown.

The word “yet” may turn out to be rather important. Also there is a catch which is sugar coated..

In the euro area, domestic demand has contributed to the recovery, helping to create 11.4 million new jobs since mid-2013.

But then reality intervenes.

But over the past ten years, domestic demand growth has been almost 2 percentage points lower on average than it was in the decade before the crisis, and it has been slower than that of our main trading partners.

In addition there is a problem.

The ECB’s accommodative policy stance has been a key driver of domestic demand during the recovery, and that stance remains in place.

This is highlighted if we think what Euro area domestic demand would have been without all the ECB stimulus. Her predecessor Mario Draghi suggested that this was in the area of a 2% boost to both GDP and inflation. I guess Christine left that out as it would be too revealing, or it could be that she is simply unaware of it.

A Double Play

The space for monetary policy is limited as Mario Draghi in what I think was a revealing move tied the new ECB President’s hands for a bit by resuming QE ( 20 billion Euros a month) and cutting the deposit rate to -0.5%. So we are left with what some might call interference in politics.

One key element here is euro area fiscal policy, which is not just about the aggregate stance of public spending, but also its composition. Investment is a particularly important part of the response to today’s challenges, because it is both today’s demand and tomorrow’s supply.

The problem is defining what investment is and which bits are  genuinely useful. For example I recall in the Euro area crisis the example of new toll roads in Portugal which were empty because people could not afford them.

However as with some many central bankers these days Christine firmly presses the climate change klaxon.

While investment needs are of course country-specific, there is today a cross-cutting case for investment in a common future that is more productive, more digital and greener.

There is a clear problem below if we look at growth prospects in the light of this speech alone.

But a stronger domestic economy also rests on higher business investment, and for that raising productivity is equally important. Firms need to be confident in future growth if they are to commit long-range capital.

Because as even Christine is forced to admit the US has done better in this area.

Though all advanced economies are facing a growth challenge, the euro area has been slower to embrace innovation and capitalise on the digital age than others such as the United States. This is also reflected in differences in total factor productivity growth, which has risen by only half as much in the euro area as it has in the United States since 2000.

How do we deal with this? Well she is a politician so bring out some large numbers that most will immediately forget.

And the projected gains are significant: new studies find that the full implementation of the Services Directive would lead to gains in the order of €380 billion], while completing the digital single market would yield annual benefits of more than €170 billion.

Comment

The most revealing part of all this is below as you know you are in trouble when politicians start talking about opportunities.

We have a unique possibility to respond to a changing and challenging world by investing in our future, strengthening our common institutions and empowering the world’s second largest economy.

Maybe by the next speech someone will have told her it is the third largest. Also what growth and why has it not be tried over the past 20 years?

In this way, we could tap into new sources of growth that would otherwise be suppressed.

Let me switch tack and welcome a new female head of a central bank but if we look at the other main example we see yet another problem. Here is Janet Yellen on CNBC.

“Some of the most disturbing notes came from people who said, ’I work and I played by the rules and I save for retirement and I have money in the bank, and you know, I’m getting absolutely nothing,” Yellen recalled. “Savers are getting penalized. It’s true.”

This is even more true in the Euro area as we looked at on Tuesday but Lagarde  just skates by.

fewer side effects

The problem has been highlighted this morning by the Markit PMI business surveys.

The eurozone economy remained becalmed for a
third successive month in November, with the
lacklustre PMI indicative of GDP growing at a
quarterly rate of just 0.1%, down from 0.2% in the
third quarter.

Another nuance is that you can read the speech as in essence the French trolling Germany which seems to be a theme these days and a source of Euro area friction.

Also if we look at money markets there may be trouble ahead.

SPIKE IN ECB’S NEW OVERNIGHT RATE ESTR THIS WEEK SPARKED BY REGULAR CONTINGENCY PLANNING BY FRENCH BANKS – TRADERS  ( @PriapusIQ )

Why the 20th of the month?

We end by returning to an all too familiar theme, why do we always need stimulus?

 

 

 

Where will Christine Lagarde lead the ECB?

We find ourselves in a new era for monetary policy in the Euro area and it comes in two forms. The first is the way that the pause in adding to expansionary monetary policy which lasted for all of ten months is now over. It has been replaced by an extra 20 billion Euros a month of QE bond purchases and tiering of interest-rates for the banking sector. The next is the way that technocrats have been replaced by politicians as we note that not only is the President Christine Lagarde the former Finance Minister of France the Vice-President Luis de Guindos is the former Economy Minister of Spain. So much for the much vaunted independence!

Monetary Policy

In addition to the new deposit rate of -0.5% Mario Draghi’s last policy move was this.

The Governing Council decided to restart net purchases under each constituent programme of the asset purchase programme (APP), i.e. the public sector purchase programme (PSPP), the asset-backed securities purchase programme (ABSPP), the third covered bond purchase programme (CBPP3) and the corporate sector purchase programme (CSPP), at a monthly pace of €20 billion as from 1 November 2019.

It is the online equivalent of a bit of a mouthful and has had a by now familiar effect in financial markets. Regular readers will recall mt pointing out that the main impact comes before it happens and we have seen that again. If we use the German ten-year yield as our measure we saw it fall below -0.7% in August and September as hopes/expectations of QE rose but the reality of it now sees the yield at -0.3%. So bond markets have retreated after the pre-announcement hype.

As to reducing the deposit rate from -0.4% to -0.5% was hardly going to have much impact so let us move into the tiering which is a way of helping the banks as described by @fwred of Bank Pictet.

reduces the cost of negative rates from €8.7bn to €5.0bn (though it will increase in 2020) – creates €35bn in arbitrage opportunities for Italian banks – no signs of major disruption in repo, so far.

Oh and there will be another liquidity effort or TLTRO-III but that will be in December.

There is of course ebb and flow in financial markets but as we stand things have gone backwards except for the banks.

The Euro

If we switch to that we need to note first that the economics 101 theory that QE leads to currency depreciation has had at best a patchy credit crunch era. But over this phase we see that the Euro has weakened as its trade weighted index was 98.7 in mid-August compared to the 96.9 of yesterday. As ever the issue is complex because for example my home country the UK has seen a better phase for the UK Pound £ moving from 0.93 in early August to 0.86 now if we quote it the financial market way.

The Economy

The economic growth situation has been this.

Seasonally adjusted GDP rose by 0.2% in the euro area (EA19…….Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 1.1% in the euro area in the third quarter of 2019 ( Eurostat)

As you can see annual economic growth has weakened and if we update to this morning we were told this by the Markit PMI business survey.

The IHS Markit Eurozone PMI® Composite
Output Index improved during October, but
remained close to the crucial 50.0 no-change mark.
The index recorded 50.6, up from 50.1 in
September and slightly better than the earlier flash
reading of 50.2, but still signalling a rate of growth
that was amongst the weakest seen in the past six and-a-half years.

As you can see there was a small improvement but that relies on you believing that the measure is accurate to 0.5 in reality. The Markit conclusion was this.

The euro area remained close to stagnation in
October, with falling order books suggesting that
risks are currently tilted towards contraction in the
fourth quarter. While the October PMI is consistent
with quarterly GDP rising by 0.1%, the forward looking data points to a possible decline in economic output in the fourth quarter.

As you can see this is not entirely hopeful because the possible 0.1% GDP growth looks set to disappear raising the risk of a contraction.

I doubt anyone will be surprised to see the sectoral breakdown.

There remained a divergence between the
manufacturing and service sectors during October.
Whereas manufacturing firms recorded a ninth
successive month of declining production, service
sector companies indicated further growth, albeit at
the second-weakest rate since January.

Retail Sales

According to Eurostat there was some good news here.

In September 2019 compared with August 2019, the seasonally adjusted volume of retail trade increased by 0.1% in the euro area (EA19). In September 2019 compared with September 2018, the calendar adjusted retail sales index increased by 3.1% in the euro area .

The geographical position is rather widespread from the 5.2% annual growth of Ireland to the -2.7% of Slovakia. This is an area which has been influenced by the better money supply growth figures of 2019. This has been an awkward area as they have often been a really good indicator but have been swamped this year by the trade and motor industry problems which are outside their orbit. Also the better picture may now be fading.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, decreased to 7.9% in September from 8.5% in August.

In theory it should rally due to the monthly QE but in reality it is far from that simple as M1 growth picked up after the last phase of QE stopped.

Comment

As you can see there are a lot of challenges on the horizon for the ECB just at the time its leadership is most ill-equipped to deal with them. A sign of that was this from President Lagarde back in September.

“The ECB is supporting the development of such a taxonomy,” Lagarde said. “Once it is agreed, in my view it will facilitate the incorporation of environmental considerations in central bank portfolios.” ( Politico EU)

Fans of climate change policies should be upset if they look at the success record of central banks and indeed Madame Lagarde. More prosaically the ECB would be like a bull in a China shop assuming it can define them in the first place.

More recently President Lagarde made what even for her was an extraordinary speech.

There are few who have done so much for Europe, over so long a period, as you, Wolfgang.

This was for the former German Finance Minister Wolfgang Schauble. Was it the ongoing German current account surplus she was cheering or the heading towards a fiscal one as well? Perhaps the punishment regime for Greece?

As to the banks there were some odd rumours circulating yesterday about Deutsche Bank. We know it has a long list of problems but as far as I can tell it was no more bankrupt yesterday than a month ago. Yet there was this.

Mind you perhaps this is why Germany seems to be warming towards a European banking union…..

Christine Lagarde has left another economic disaster behind her in Argentina

One of the rules of modern life is that the higher up the chain you are or as Yes Prime Minster put it “the greasy pole” the less responsible you are for anything. A clear example of that is currently Christine Lagarde who is on here way to becoming the next President of the European Central Bank and found her competence being praised to the heavens in some quarters. Yet the largest ever IMF programme she left behind continues to fold like a deckchair. From the Argentina central bank or BCRA this morning via Google Translate.

Measures to protect exchange-rate stability and the saver

There are two immediate perspectives. The first is that we need to translate the announcement which suggests as a minimum a modicum of embarrassment. Next when central banks tell you that you are being protected it is time to think of the strap line of the film The Fly.

Be Afraid, Be Very Afraid

Let us look at the detail.

The measure establishes that exporters of goods and services must liquidate their foreign exchange earnings in the local market……Resident legal entities may purchase foreign currency without restrictions for the importation or payment of debts upon expiration, but they will need compliance from the Central Bank of the Argentine Republic to purchase foreign exchange for the formation of external assets, for the precancelation of debts, to turn abroad profits and dividends and make transfers abroad.

So some restrictions on businesses and here are the ones on the public.

Humans will not have any limitations to buy up to USD 10,000 per month and will need authorization to buy amounts greater than that amount. Transactions that exceed USD 1,000 must be made with a debit to an account in pesos, since they cannot be carried out in cash. Nor will it be allowed to transfer funds from accounts abroad of more than USD 10,000 per person per month. Except between accounts of the same owner: in this case there will be no limitations.

If you are not Argentinian then the noose is a fair bit tighter.

Non-resident human and legal persons may purchase up to USD 1,000 per month and may not transfer funds from dollar accounts abroad.

What about the debt?

We need a bit of reprogramming here after all it has been party-time for bondholders in most of the world. However as Reuters points out not in Argentina.

Standard & Poors announced on Thursday that it was slashing Argentina’s long-term credit rating another three notches into the deepest area of junk debt, saying the government’s plan to “unilaterally” extend maturities had triggered a brief default. The ratings agency said it would consider Argentina’s long-term foreign and local currency issue ratings as CCC- “vulnerable to nonpayment” – starting on Friday following the government’s Wednesday announcement that it wants to “re-profile” some $100 billion in debt.

That’s more than a bit awkward for those who bought the 100 year bond which was issued in 2017. It was also rather difficult for the IMF which seems to have found itself in quicksand.

By the time Treasury Minister Hernan Lacunza said on Wednesday that the government wanted to extend maturities of short-term debt, and would negotiate new time periods for loans to be paid back to the International Monetary Fund, a debt revamp was already widely expected.

We will have to see how the century ( now 98 year ) bond does but after being issued at 85 it traded at 38 last week. In a sign of the times even the benchmark bond which in theory pays back 100 in 2028 did this.

The January 2028 benchmark briefly dropped under 40 cents for the first time ever before edging up to trade at 40.3.

For perspective Austria also issued a century bond at a similar time and traded at 202 last week.

The Peso

Back on August 12th I pointed out that it took 48.5 Pesos to buy a single US Dollar ahead of the official opening. Things went from bad to worse after the official opening with the currency falling into the mid-50s in a volatile market. On Friday it closed at 59.5 and that was after this.

The central bank has burnt through nearly $1 billion in reserves since Wednesday in an effort to prop up the peso. But the intervention did not have the desired impact and risk spreads blew out to levels not seen since 2005, while the local peso currency extended its year-to-date swoon to 36%. ( Reuters ).

If we stay with the issue of reserves I note that the BCRA itself tells us that as of last Wednesday it had US $57 billion left as opposed to this from my post on August 12th.

But staying with the central bank maybe it will be needing the US $66.4 billion of foreign exchange reserves.

I was right and the nuance here is shown by how little of the reserves were actually deployable in a crisis. We know 14% were used and at most 20% have now been used yet policy has been forced to change. That is a common theme of a foreign exchange crisis you only end up being able to use if I an generous half of your reserves before either you press the panic button or someone does it for you.

Interest-Rates

Here we see another departure from the world-wide trend as rather than falls we are seeing some eye-watering levels. Back on August 12th I noted an interest-rate of 63.71% whereas now it is 83.26%. This provides another perspective on the currency fall because you get quite decent return for these times if you can merely stay in the Peso for a week or two.

As for the domestic economy such an interest-rate must be doing a lot of damage because of the length of time this has lasted for as well as the number now.

Comment

As recently as June 7th last year the IMF announced this.

The Argentine authorities and IMF staff have reached an agreement on a 36-month Stand-By Arrangement (SBA) amounting to US$50 billion (equivalent to about SDR 35.379 billion or about 1,110 percent of Argentina’s quota in the IMF).

The amount has been raised since presumably because of the rate of access of funds. If you look at the IMF website it has already loaned just short of 33 billion SDRs. Meanwhile here is some gallows humour from back then.

The authorities have indicated that they intend to draw on the first tranche of the arrangement but subsequently treat the loan as precautionary.

As Christine Lagarde was cheerleading for this she did get one thing right.

I congratulate the Argentine authorities on reaching this agreement

They kept themselves in power with the help of IMF funds. That has not gone so well for the Argentine people not the shareholders of the IMF. There are similarities here with the debacle in Greece where of course Christine Lagarde was heavily involved in the “shock and awe” bailout that contributed to an economic depression. For example as 2018 opened the IMF forecast 2.5% economic growth for it and 2.8% this year as opposed to the reality of the numbers for the first quarter being 5.8% lower than a year before.

Yet as recently as April she was telling us this.

When the IMF completed its third review of Argentina’s economy in early April, managing director Christine Lagarde boasted that the government policies linked to the country’s record $56bn bailout from the fund were “bearing fruit”.

It is not an entirely isolated event as we look at other IMF programmes.

Pakistan Rupee -4.83% seems IMF’s (Lagarde’s) lesser-known second success story. Eurozone you are next up ( @Sunchartist )

But the official view has been given by Justin Trudeau of Canada who has described Christine Lagarde as a “great global leader.”

Podcast

What will be the policies of a Lagarde run ECB?

We face something of a new era in central banking as the announcement of the former French Finance Minister Christine Lagarde as the next President of the European Central Bank poses a problem. This is exacerbated by the fact that the former Spanish Finance Minister Luis De Guindos was appointed at the Vice-President of the ECB in March last year. So as you can see these roles seem to be becoming a nice retirement present for former finance ministers which poses a clear problem when the ECB was set up to avoid them running monetary policy!

Central banks have not always been independent, but over time there has been a clear trend towards separating monetary policy from direct political influence……… If governments had direct control over central banks, politicians could be tempted to change interest rates in their favour to create short-term economic booms or use central bank money to finance popular policy measures. ( ECB)

The spinning involved here is an example of the military dictum that the best place to hide something is in plain sight. This particularly matters if we consider the issue of QE ( Quantitative Easing ) bond buying which relies on the separation of the central bank and the treasury (treasuries in this case). Otherwise the treasury may just buy its own bonds meaning we would have a literal case of money printing.

Monetary Policy

There are three routes which will give us a clue as to what the Lagarde era will bring.

The first is the likelihood that she will inherit policy which has just been eased again. As we have been analysing the present President Mario Draghi intends to go out with something of a bang. So a further cut in the Deposit Rate from the present -0.4% is on the cards with some extra QE as well. I do not know if he got wind of the next President and decided to set monetary policy for the early part of the next term but it certainly feels like that now. Personally I find it hard to take a cut from -0.4% to -0.5% seriously as exactly is the extra -0.1% expected to achieve?

Next comes some research which was published this February whilst she was Managing Director of the IMF.

In a cashless world, there would be no lower bound on interest rates. A central bank could reduce the policy rate from, say, 2 percent to minus 4 percent to counter a severe recession. The interest rate cut would transmit to bank deposits, loans, and bonds.

This is especially relevant to a central bank which has sailed into the next slow down with interest-rates still negative. Then the advent of something like Libra starts to look potentially rather sinister.

The proposal is for a central bank to divide the monetary base into two separate local currencies—cash and electronic money (e-money). E-money would be issued only electronically and would pay the policy rate of interest, and cash would have an exchange rate—the conversion rate—against e-money.

This all seems a little odd but as Al Pacino tells us in Carlito’s Way, here comes the pain.

To illustrate, suppose your bank announced a negative 3 percent interest rate on your bank deposit of 100 dollars today. Suppose also that the central bank announced that cash-dollars would now become a separate currency that would depreciate against e-dollars by 3 percent per year. The conversion rate of cash-dollars into e-dollars would hence change from 1 to 0.97 over the year. After a year, there would be 97 e-dollars left in your bank account. If you instead took out 100 cash-dollars today and kept it safe at home for a year, exchanging it into e-money after that year would also yield 97 e-dollars.

It is all very involved and they do not put it like this but those with cash are being taxed. At no point does anyone question why we need such negative interest-rates? After all we have had loads of interest-rate cuts and by definition they have not worked or we would not need ever more of them. So why would this work? It plainly fails the Einstein critique which defines madness as doing the same thing but expecting a different result.

Philip Lane

Not a well known name outside of Ireland but the previous Governor of the Irish central bank is now the chief economist of the ECB. As his two superiors have little experience or expertise in monetary policy ( I recall Mario Draghi once saying he would find a job for De Guidos when they could find a job he could do….) the role of chief economist just got much more important. On Tuesday in Helsinki he updated us on his thoughts.

 As will be explained in the analysis, my assessment is that the evidence shows that our package of monetary policy measures has been an effective response to the environment that the ECB has faced in recent years.

So effective in fact that in spite of negative interest-rates and a bloated balance sheet it has slowing economic growth and inflation below target. Yet we are told everything is working just fine.

To illustrate the effectiveness of negative policy rates, ECB staff undertook a counterfactual exercise………The evidence shows that our enhanced forward guidance has been effective……According to those estimates, after the last recalibration of the APP in June 2018, the ten-year bond yield would have been around 95 basis points higher in the absence of the APP. Moreover, this impact is quite persistent……..In fact, our experience with previous TLTROs (TLTRO I and II) was that these operations had a significant effect on funding costs, particularly in more vulnerable euro area countries. Moreover, the lower funding costs were passed through to customers

Now I do not know about you but after around 5 years of something why can’t you look at what negative interest-rates have achieved rather than running a simulation? Also if lower bond yields were an economic nirvana the Euro area would be in a form of economic rapture right now. Ditto for the bank subsidy TLTROs. I suppose as Chief Economist he has to claim that people take note of Forward Guidance but I also note that even he does not claim it goes beyond financial markets. Quite how the ordinary person is supposed to respond to something they have never heard of gets omitted.

But after all the psychobabble we get the punch line. It is to be “More! More! More!”

Our assessment is that this policy package has been effective and further easing can be provided if required to deliver our mandate.

Comment

As you can see the mood music is all on one direction. Christine Lagarde headed an organisation which has pushed for higher inflation targets and even deeper negative interest-rates. It seems that her arrival will follow new QE purchases which will cause the need for more “innovation” because under the present rules there are not so many left to buy. So there are roads ahead where she will announce the buying of equities and corporate property like in Japan. Markets seem to have got the gist as I note that the ten-year yield in Germany has fallen below the -0.4% Deposit Rate of the ECB this morning. Buy bonds today and sell them to Christine later seems to be the name of the game right now.

The music must never stop even though after all this time even the most credulous must surely ask why we never seem to escape from the economic malaise?

So it is not only in the sphere of corruption that the song below from the Stranglers is appropriate.

Nice ‘N’ Sleazy
Nice ‘N’ Sleazy
Does It Does It
Does It Every Time
Nice ‘N’ Sleazy
Nice ‘N’ Sleazy
Does It Does It
Does It Every Time
Nice ‘N’ Sleazy Does It

I would imagine I am not the only person wondering how banking fraud will be dealt with on her watch?

The Investing Channel

 

 

 

Governor Carney sees his interest-rate promises crumble again

Yesterday was quite a day in the life of Bank of England Governor Mark Carney as he faced the problems created by his own Forward Guidance on interest-rates, but later saw one of his hopes and dreams hover tantilisingly in the distance. It will have provided some variety as he pressed the control P button to make sure plenty of copies of his CV were ready to be sent to the International Monetary Fund rather than the usual printing of money. I will look more later at the developments there which had a side-effect of putting a tsunami through even the most fanatical adherents to the cult that continues to claim central banks are politically independent.

Also he was something of a TV star as well as apparently co-writing the script for the BBC2 documentary on the Bank of England.

The Bank is responsible for ensuring our money holds its value and it works tirelessly to protect the economy from the threat of high inflation.

Back to his current job

Governor Carney gave a speech to the Local Government Association and opened with a sentence which seemed to apply to the Bank of England.

These productions will mix tragedy and
comedy in a play whose themes range from magic and creation to betrayal and revenge.

Also if we move on from the PR spinning of the BBC documentary the Governor has a problem which he summarised like this.

In recent months, the expected paths of policy interest rates in advanced economies have shifted sharply
lower, most notably in the US where an expectation of two further rate hikes over the next three years has
flipped to four rate cuts by the end of next year. In the euro area, markets have begun to price in further rate
reductions and asset purchases

He could have mentioned that the Reserve Bank of Australia had cut interest-rates at two meetings in a row that day, which repeated what the Reserve Bank of India had already done earlier in 2019.

This is a problem because he has been giving Forward Guidance about interest-rate increases as the rest of the world has been planning for cuts. Here is how he explained this.

If Brexit progresses smoothly, we expect that the current heightened uncertainties facing companies and
households will fade gradually, business investment will rebound, the housing market to rally, and
consumption to grow broadly in line with households’ real incomes. This would accelerate economic growth,
strengthen domestic inflationary pressures, and require limited and gradual increases in interest rates in
order to return inflation sustainably to the 2% target.

So the UK economy would be able to stand aside from the trends affecting the rest of the world? For a country where trade is a very important part of the economy this is just a fantasy. What is an unreliable boyfriend to do in such circumstances? Step one is of course to put the blame elsewhere.

It is unsurprising that the path of interest rates consistent with achieving the inflation target in this scenario
differs from current market pricing of a lower expected path for Bank Rate given that the market places
significant weights on both the probability of No Deal and on cuts in Bank Rate in that event.

Yes the Brexit Klaxon has been deployed yet again by Governor Carney. This is an attempt to put a smokescreen over the fact that the world economy has been slowing for nearly a year now. After all the economy of Germany contracted in the third quarter of 2018. This morning’s weakening of the Caixin PMI in China notes that today’s weaker number for June is the lowest since October last year. Or to point it another way the attempt by Governor Carney to claim trade tariff problems started in May is an innovative version of history.

Actually in the course of a mere three sentences the Governor contradicts himself.

It just highlights the extent to which the levels of interest rates, sterling and other asset prices might increase if a deal were reached.

Becomes this.

We will also make a detailed assessment of the potential implications of the global sea change currently
underway.

In a smooth Brexit sterling and asset prices are likely to rise although of course many equities do not like higher sterling. But interest-rates higher in a “global sea change”?

Markets

The antennae of financial markets quickly picked up the hint that the unreliable boyfriend was limbering up to go on tour again. This saw the UK Gilt market continue its recent bull run and led to a couple of developments that will have embarrassed Governor Carney. Firstly the UK ten-year Gilt yield fell below the 0.75% Bank Rate and is 0.7% as I type this. Even more so both the two and five-year yields have fallen to 0.5% this morning so they are implying a 0.25% cut which is precisely the opposite of the rises in the Forward Guidance of Governor Carney.

Just as a reminder here is the BBC from the second of May.

Interest rate increases could be “more frequent” than expected if the economy performs as the Bank of England is expecting, governor Mark Carney says.

UK economy

There are doubts as to how accurate the Markit PMI business surveys are as we have seen them get things wrong such as late summer 2016 in the UK. But we also know that the Bank of England looks at it closely as it used it as a signal on its way to cutting Bank Rate to 0.25% in August of that year. So many eyes in Threadneedle Street will have been on this.

At 49.2 in June, the seasonally adjusted All Sector Output
Index fell from 50.7 in May and signalled a reduction in
overall private sector business activity for the first time in 35 months.

This was because the services sector at 50.2 was unable to offset the weaker manufacturing and construction estimates.

Comment

Governor Carney is preparing for yet another U-Turn as his Forward Guidance crumbles yet again in the face of reality. As a consistently unreliable boyfriend I guess he has a list of excuses ready for this. Yet as the day developed there was a further double-swing. The announcement that Christine Lagarde would leave the IMF and become President of the ECB had one clear positive for Governor Carney as the job he has long coveted suddenly became available hence my CV reference earlier. Perhaps he will discover some French ancestry too.

But this had a much more problematic swing as I note the words of the UK Chancellor Philip Hammond.

UK’s Hammond says Bank of England must not be politicized.

That initially provoked thoughts of the current Governor who attracted criticism for playing politics in his time as Governor of the Bank of Canada and has repeated that in the UK. However the appointment of a former French Finance Minister to head the ECB destroyed any fantasies of central banks being politically independent. After all she will be working with a Vice President ( De Guindos) who was formerly the Spanish Finance Minister. Can anybody spot a trend here?

This brought out a barrage of Fake News. For example Madame Lagarde was described as having a good reputation as others were pointing out this.

Useful reminder: Lagarde was judged guilty of gross negligence (ahem) by a French court over the insane payment to Bernard Tapie in the Credit Lyonnais case but escaped the one year jail sentence because (quoting) Of her « personnality» and “international reputation” and the fact that at the time she was fighting an « international financial crisis » ( @jeuasommenulle )

There was a time when being convicted in a fraud case would debar you from any sort of financial role let alone major ones. In the ordinary person’s world the CV would simply have been rejected. Still some places are managing to report that the ECB is safe from political interference now which really is an insult to readers.

Even the supporters of Madame Lagarde seem to be a bit thin on evidence that she has any real grasp of monetary policy. We do know that she helped put the Greek economy into an economic depression with the “shock and awe” policies of 2010 and 11 which she so vociferously supported. So in conclusion it was a good idea to pick a woman but a really bad idea to choose her.

What should we do about the International Monetary Fund?

Yesterday’s events give us an opportunity to look again at one of the longest-running themes of my writing on here. This is the role of the IMF and to do so I would like to take you back to the 8th of June 2010 when I pointed out this.

1. It has plainly changed from an organisation which helps with balance of payments problems to one which helps with fiscal deficits. Whilst this may suit politicians, taxpayers and voters should in my view be concerned about the moral hazard of one group of politicians voting to increase funds available to help another group of politicians which may include themselves.

This was my response back then to the way that the Dominique Strauss-Khan who was Managing Director of the IMF at the time allowed it to get involved in the Euro area crisis. There was an obvious issue in a French politician doing this and of course the IMF has continued with French political heads. It worried me at the time on various grounds one of which was that poor third world countries were in essence financing a bailout of a much wealthier area overall which could afford to collectively pay for it. In my opinion the reason for this was that whilst Euro area political leaders ( including the French Finance Minister at the time one Christine Lagarde) were proclaiming “shock and awe” in fact the Euro area response was a mess. The so-called rescue vehicle the European Financial Stability Facility (EFSF) was anything but which my updates from back then show. Over time they have proved this as it was later replaced with the European Stability Mechanism or ESM.

But the fundamental point here was that a modus operandi which involved balance of payments problems was replaced by a fiscal one. This line could be covered up to some extent in Greece as it also had a balance of payments problem but not for example in Ireland which has surpluses pretty much as often as the UK has deficits!

Greece

This of course has been a debacle for the IMF where whatever reputation it had for economic competence has come a cropper as Greece was plunged even further into recession and in fact has yet to emerge from the economic depression created. This contrasts with the official view which I pointed out on March 30th of this year.

but from 2012 onward, improved market confidence, a return to credit markets, and comprehensive structural reforms, are expected to lead to a rebound in growth.

There was supposed to be economic growth starting in 2012 and then running at around 2.1% for two years and then pick-up to 2.7% in 2015.. Then once that obviously did not happen we got the “Grecovery” theme which did not happen either. Along the way we got a “mea culpa” from the IMF as well as something of a hand brake turn as the advocate of austerity became a fan of fiscal deficits.

However something was wrong and at least some in the IMF knew it’ Let me take you back again to the 8th of June 2010.

Mr.Boutros-Ghali (Egypt’s Finance Minister) went on to give us some idea of one of the areas he feels that trouble and hence further demands for funds might come from. He told the Reuters news agency that Greece’s problems were not over yet and there were doubts about its ability to implement the reforms demanded by the IMF and European Union in return for a 110 billion euro aid package.

 

“We are not out of the woods,” he said in the interview. “The measures they have been required to implement are fairly tough. And there are in some areas doubts whether they are able to continue implementing such tough measures.”

He was of course correct and it is a sad indictment of these times that official sources are still claiming progress on reforms when reality has been very different. After all Greece would not be in the state it is in if they had worked or even been applied. In my opinion there is something worse than the mistakes which is the way that there has been deliberate dissembling and misrepresentation of not only what is going to happen but what is happening at the time.

The implication that the IMF is free

Another feature of IMF aid is the way that it is presented as a type of SPV and sadly not the Spectrum Pursuit Vehicle driven mostly by Captain Blue in my and many other’s childhoods. These official SPVs ( such as the EFSF) are off-balance sheet vehicles which allow politicians to obfuscate about the state of play. Back to June 8th 2010 again.

Politicians should stop implying that the help provided by the IMF is in effect free. For example US Treasury Secretary Geithner suggested that moves to expand the IMF “wouldn’t cost a dime”. This is one of those superficially true statements that are very dangerous. If you are liable for something it does not cost anything until it goes wrong. Just to quote the IMF itself there are “doubts” over Greece. Any proper accounting system allows for the possibility of things going wrong. After the experience of the last two years we should know the implication of sticking your head in the sand like an ostrich and assuming there are no problems around…

In other words it is presented as “free” until it isn’t at which point phrases such as “this could not have been reasonably expected” and words such as “counterfactual” are deployed as weapons. Missing from the conversation is how people who were are regularly told are so intelligent and thus need to be paid highly have been wrong again! This of course brings us to the concept of responsibility.

Christine Lagarde

I have been critical of the IMF’s Managing Director quite a few times on the grounds that she has been intimately involved with the disastrous bailout of Greece via her roles as French Finance Minister and Managing Director of the IMF. Not everyone has spotted this as the Financial Time has proved this morning as it reviews her.

a blow to her previously unblemished reputation for managerial competence

But even the FT which appears ever keen to stand firmly behind any establishment vehicle has to admit this.

A conviction for negligence is somewhat at odds with a commitment to “the highest standards of efficiency and technical competence”.

Mind you perhaps something in the past has influenced this.

The Financial Times therefore argued earlier this year that she deserved reappointment for a second term on merit.

Is negligence the new definition of merit? I will have to update my financial lexicon for these times. This next bit is full on internal contradictions and effectively self-critiques.

It found her guilty of negligence because she did not appeal against the eventual decision — but it has not imposed any sentence, and the verdict will not result in a criminal record. Short of full exoneration, this is the mildest possible verdict.

This is an unusual verdict from an unusual court. Politicians who sit on the special tribunal may well have wished to avoid a tougher ruling that would have deterred ministers from making delicate decisions in future.

Comment

There are a litany of issues here. We see yet again that the more important you are the less you are apparently responsible for anything. Someone lower down the scale would have received punishment if they had been found guilty of negligence yet the leader of the world’s major financial organisation apparently can shrug it off. Punishment is for the little people only it would seem.

This leaves the IMF as a whole in an even bigger hole. As the economic world shifts east towards places like India and China it looks ever more like a western and to some extent French fiefdom. At the same time more of its bailouts have gone rogue of which Greece is the most extreme example. The worst part is the way that this is all covered-up and the truth is bent and miss shaped.

The only hope we have is that this statement from the IMF turns out to be like one about a manager from a football club’s board of directors.

In this context, the Executive Board reaffirms its full confidence in the Managing Director’s ability to continue to effectively carry out her duties.

Oh and “outstanding leadership” also needs to go into my financial lexicon for these times. Although we do need perhaps to go through the Looking Glass of Lewis Carroll.

“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”