Is Japan the future for all of us?

A regular feature of these times is to compare our economic performance with that of Japan. That has propped up pretty regularly in this crisis mostly about the Euro area but with sub-plots for the US and UK. One group that will be happy about this with be The Vapors and I wonder how much they have made out of it?

I’m turning Japanese, I think I’m turning Japanese
I really think so
Turning Japanese, I think I’m turning Japanese
I really think so.

The two basic concepts here are interrelated and are of Deflation and what was called The Lost Decade but now are The Lost Decades. These matters are more nuanced that usually presented so let me start with Deflation which is a fall in aggregate demand in an economy. According to the latest Bank of Japan Minutes this is happening again.

This is because aggregate demand is
highly likely to be pushed down by deterioration in the labor market and the utilization rate of conventional types of services could decline given a new lifestyle that takes into
consideration the risk of COVID-19.

The latter point echoes a discussion from the comments section yesterday about an extension to the railway to the Scottish Borders. Before COVID-19 anything like that would come with a round of applause but now there are genuine questions about public transport for the future. There is an irony close to me as I have lived in Battersea for nearly 3 decades and a tube line there has been promised for most of that. Now it is on its way will it get much use?

This is a difficult conceptual issue because if we build “White Elephants” they will be counted in GDP ( it is both output and income), but if they are not used the money is to some extent wasted. I differ to that extent from the view of John Maynard Keynes that you can dig and hole and fill it in. If that worked we would not be where we are now. In the credit crunch we saw facets of this with the empty hotels in Ireland, the unused airport in Spain and roads to nowhere in Portugal. That was before China built empty cities.

Inflation Deflation

There is something of a double swerve applied here which I will illustrate from the Bank of Japan Minutes again.

Next, the three arrows of Abenomics should continue to be carried out to the fullest extent until the economy returns to a growth path in which the annual inflation
rate is maintained sustainably at around 2 percent.

A 2% inflation target has nothing at all to do with deflation and this should be challenged more, especially when it has this Orwellian element.

It is assumed that achievement of the price stability target will be delayed due to COVID-19
and that monetary easing will be prolonged further

It is not a price stability target it is an inflation rate target. This is of particular relevance in Japan as it has had stable prices pretty much throughout the lost decade period. It is up by 0.1% in the past year and at 101.8 if we take 2015 as 100, so marginal at most. The undercut to this is that you need inflation for relative price changes. But this is also untrue as the essentially inflation-free Japan has a food price index at 105.8 and an education one of 92.7.

Policy Failure

The issue here is that as you can see above there has been a complete failure but that has not stopped other central banks from speeding down the failure road. It is what is missing from the statement below that is revealing.

: the Special Program to Support Financing in Response to the Novel Coronavirus (COVID-19); an ample provision of
yen and foreign currency funds without setting upper limits; and active purchases of assets such as exchange-traded funds (ETFs).

No mention of negative interest-rates? Also the large-scale purchases of Japanese Government Bonds only get an implicit mention. Whereas by contrast the purchase of equities as in this coded language that is what “active purchases of assets such as exchange-traded funds (ETFs)” means gets highlighted. The 0.1% will be happy but as any asset price rise is omitted from the inflation indices it is entirely pointless according to their stated objective. No wonder they keep failing…

This matters because pretty much every central bank has put on their running shoes and set off in pursuit of the Bank of Japan. Ever more interest-rate cuts and ever more QE bond buying. Perhaps the most extreme case is the ECB (European Central Bank) with its -0.5% Deposit Rate and large-scale QE. On the latter subject it seems to be actively mirroring Japan.

The ECB may not need to use the full size of its recently expanded pandemic purchase program, Executive Board member Isabel Schnabel says ( Bloomberg)

This is a regular tactic of hinting at reductions whereas the reality invariably ends up on the Andrea True Connection road.

More! More! More!

Staying with the Euro area the ECB has unveiled all sorts of policies and has a balance sheet of 6.2 trillion Euros but keeps missing its stated target. We noted recently that over the past decade or so they have been around 0.7% per year below it and that is not getting any better.

In June 2020, a month in which many COVID-19 containment measures have been gradually lifted, Euro area annual inflation is expected to be 0.3%, up from 0.1% in May ( Eurostat )

Real Wage Deflation

This to my mind is the bigger issue. It used to be the case ( in what was called the NICE era by former Bank of England Governor Mervyn King) that wages grew faster than wages by 1-2% per annum. That was fading out before the credit crunch and since there have been real problems. The state of play for the leader of the pack here has been highlighted by Nippon.com.

Wage growth in Japan is also slow compared with other major economies. According to statistics published by the Organization for Economic Cooperation and Development, the average Japanese annual wage in 2018 was the equivalent of $46,000—a mere 0.2% increase on the figure for 2000 ($45,000).

They mean 2% and everyone else seems to be heading that way.

This increase is significantly smaller than those recorded in the same period in the United States ($53,900 to 63,100), Germany ($43,300 to 49,800), and France ($37,100 to 44,500).

The UK has gone from around $39,000 to the same as France at $44.500.

There is an obvious issue in using another currency but we have the general picture and right now it is getting worse everywhere.

Comment

The answers to the question in my title unfold as follows. In terms of central bank action we have an unequivocal yes. They have copied Japan as much as they can showing they have learnt nothing. We could replace them with an AI version ( with the hope that the I of Intelligence might apply). Related to this is the inflation issue where all the evidence is that they will continue to fail. We have here an example of failure squared where they pursue policies that do not work in pursuit of an objective which would make people worse rather than better off.

That last point feeds into the wages issue which in my opinion is the key one of our times. The Ivory Towers of the central banks still pursue policies where wages growth exceeds inflation and their models assume it. Perhaps because for them it is true. But for the rest of us it is not as real wages have struggled at best and fallen at worst. This is in spite of the increasingly desperate manipulation of inflation numbers that has been going on.

So we see different elements in different places. The Euro area is heading down the same road as Japan in terms of inflation and apart from Germany wages too. The UK is an inflation nation so that part we are if not immune a step or two away from, but that means our real wage performance is looking rather Japanese.

There is also another sub-plot.

30y gilt yield < 30y JGB yield ( Divyang Shah )

The Investing Channel

 

The ECB is creating Euros even faster than Wirecard can lose them

The focus shifts today to the Euro area as there has been action on a number of fronts. Firstly the world’s second most notable orange person has been speaking at the online Northern Lights Summit. The Orangina Christine Lagarde seems to have upset the folk at ForexLive already.

Lagarde reaffirms that government debt will eventually have to be repaid

No. Just no. Governments will never run surpluses just with a snap of a finger and what is happening to the world and their debt levels now is basically what we have seen with Japan over the past two decades.

Actually before the pandemic Germany was running surpluses but the majority were not. We also got some classic Christine Lagarde as she waffled.

FRANKFURT (Reuters) – The euro zone is “probably past” the worst of the economic crisis caused by the coronavirus pandemic, European Central Bank President Christine Lagarde said on Friday, while urging authorities to prepare for a possible second wave.

“We probably are past the lowest point and I say that with some trepidation because of course there could be a severe second wave,” Lagarde told an online event.

At least she is not declaring success as Greeks and Argentinians have learnt to be terrified of what happens next after painful experience.

Also there has been this.

FRANKFURT (Reuters) – It is better for the European Central Bank to be safe than sorry when it decides whether to withdraw aggressive stimulus measures deployed to combat the fallout from the coronavirus pandemic, ECB policymaker Olli Rehn said on Friday.

“It’s better to be safe than sorry,” Rehn said. “Recall the premature rate hikes of 2011 during the euro crisis.”

This is a classic strategy where a policymaker suggests things may be reduced (yesterday) and today we have the good cop part of this simple Good Cop,Bad Cop pantomime.

Money Supply

Back on the 29th of May I pointed out that the blue touch paper had been lit on the  money supply boom of 2020. Well the rocket is lifting off.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, increased to 12.5% in May from 11.9% in April.

That compares with the recent nadir of an annual rate of 6.2% in January of 2019. Another comparison is that the rate of annual growth was around 8% before the latest phase of monetary action such as the extra Quantitative Easing of the PEPP. The weekly reporting does not exactly match a month but we saw an extra 116 billion Euros in May from it.

You will not be surprised to learn that the surge above pushed broad money growth higher as well.

Annual growth rate of broad monetary aggregate M3, increased to 8.9% in May 2020 from 8.2% in April (revised from 8.3%).

Indeed it is mostly a narrow money thing.

Looking at the components’ contributions to the annual growth rate of M3, the narrower aggregate M1 contributed 8.4 percentage points (up from 8.0 percentage points in April), short-term deposits other than overnight deposits (M2-M1) contributed 0.2 percentage point (up from -0.1 percentage point) and marketable instruments (M3-M2) contributed 0.3 percentage point (as in the previous month).

The pattern here is not quite the same as whilst the January 2019 reading at 3.8% was low the nadir is 3.5% in August of 2018. That provides some food for thought because if you apply the expected response to this the Euro area economy should have been slowing further about now. Of course the pandemic has created such a fog we cannot see one way or another about whether that held true.

There is another way of analysing this and here is a balance sheet style view.

credit to the private sector contributed 5.3 percentage points (up from 4.8 percentage points in April), credit to general government contributed 3.6 percentage points (up from 2.3 percentage points), net external assets contributed 1.0 percentage point (down from 1.4 percentage points), longer-term financial liabilities contributed 0.0 percentage point (as in the previous month), and the remaining counterparts of M3 contributed -0.9 percentage point (down from -0.3 percentage point).

I counsel caution about reading too much into this as back in the day such analysis when spectacularly wrong in the UK. Accounting identities are all very well but they miss the human component as well as some of the actual numbers. But we see growth from the government sector and the private-sector here. Also the external component has faded a bit in relative terms which provides a counterpoint to another piece of news.

Grandstanding?

From yesterday when all our troubles apparently not so far away.

Eurosystem repo facility for central banks (EUREP) introduced as precautionary backstop to address pandemic-related euro liquidity needs outside euro area….EUREP to allow broad set of central banks to borrow euro against euro-denominated debt issued by euro area central governments and supranational institutions….New facility to be available until June 2021.

These things are invariably badged as temporary but last time I checked the “temporary” income tax in the UK to pay for the Napoleonic War is still here. But as to what good it might do in a world where nobody seems to actually want Euros in this manner I am not sure. Perhaps it is a protection against another outbreak of the “Carry Trade” as this bit hints.

The provision of euro liquidity to non-euro area central banks aims at alleviating euro liquidity needs in the respective countries in a stressed market environment. The
potential beneficiaries are banks that need euro funding and are not able to obtain such funding in the market or get it only at prohibitive prices.

Although there is no real link at all to this.

Overall, these arrangements aim to facilitate a smooth transmission of monetary policy in the euro
area to the benefit of all euro area citizens

Let me help out bu suggesting replacing “all euro area citizens” with “The Precious! The Precious!”.

Here is what is presumably the official view from former ECB Vice-President Vitor Constancio. You may recall that Vitor’s job was to respond with technical questions at the ECB presser with a long involved answer that would send everyone to sleep. But at least he had a role unlike his replacement.

The ECB, reflecting awareness about the international role of the euro, just announced a new repo facility for other central banks to get euros against collateral.The FED dit it recently ..In general, the EU is finally aware of its geo-political interests.

The Fed saw demand of over US $400 billion at the peak whereas I suspect the Euro interest may be more like 0. Maybe someone will request a million or two as a test?

Comment

The relevance of the money supply changes is as follows. Narrow money supply impacts in the next 6 months and broad money in around two years. So assuming there is no Covid-19 second wave the push will impact as economies are picking up anyway. That is awkward as there is a clear inflation danger from this. There are signs of it already as we see the oil price pick up which even the neutered official inflation numbers will record. They of course miss the bit described by Abba.

Money, money, money
Must be funny
In the rich man’s world
Money, money, money
Always sunny
In the rich man’s world

Although we do see evidence of a type of money destruction.

Germany’s Wirecard collapsed on Thursday owing creditors almost $4 billion. ( Reuters )

The regulators are now on the case but.

All the money’s gone, nowhere to go ( The Beatles )

The ECB bails out the banks yet again, the Euro area economy not so much

One of the battles in economics is between getting data which is timely and it being accurate and reliable. Actually we struggle with the latter points full stop but especially if we try to produce numbers quickly. As regular readers will be aware we have been observing this problem in relation to the Markit Purchasing Manager Indices for several years now. They produce numbers which if this was a London gangster movie would be called “sharpish” but have missed the target on more than a few occasions and in he case of the Irish pharmaceutical cliff their arrow not only missed the target but the whole field as well.

Things start well as we note this.

The eurozone economic downturn eased markedly
for a second successive month in June as
lockdowns to prevent the spread of the coronavirus
disease 2019 (COVID-19) outbreak were further
relaxed, according to provisional PMI® survey data.
The month also saw a continued strong
improvement in business expectations for the year
ahead.

As it is from the 12th to the 22nd of this month it is timely as well but then things go rather wrong.

The flash IHS Markit Eurozone Composite PMI rose
further from an all-time low of 13.6 seen back in
April, surging to 47.5 in June from 31.9 in May. The
15.6-point rise was by far the largest in the survey
history with the exception of May’s record increase.
The latest gain took the PMI to its highest since
February, though still indicated an overall decline in
business output.

Actually these numbers if we note the Financial Times wrong-footed more than a few it would appear.

The rise in the eurozone flash Composite PMI in June confirms that economic output in the region is recovering rapidly from April’s nadir as restrictions are progressively eased. ( Capital Economics )

Today’s PMI numbers provide further evidence of what initially looks like a textbook V-shaped recovery. As much as more than a month of (full) lockdowns had sent economies into a standstill, the gradual reopenings of the last two months have led to a sharp rebound in activity. ( ING Di-Ba)

The latter is an extraordinary effort as a number below 50 indicates a further contraction albeit with a number of 47.5 a minor one. So we have gone enormous contraction , what would have been called an enormous contraction if they one before had not taken place and now a minor one. But the number now has to be over 50 as the economy picks up and this below is not true.

Output fell again in both manufacturing and
services, the latter showing the slightly steeper rate
of decline

On a monthly basis output rose as it probably did at the end of last month, it is just that it is doing so after a large fall. The one number which was positive was still way too low.

Flash France Composite Output Index) at 51.3
in June (32.1 in May), four-month high.

For what it is worth the overall view is as follows.

We therefore continue to expect GDP to slump by over 8% in 2020 and, while the recovery may start in the third quarter, momentum could soon fade meaning it will likely
take up to three years before the eurozone regains
its pre-pandemic level of GDP.

Actual Data

From Statistics Netherlands.

In May 2020, prices of owner-occupied dwellings (excluding new constructions) were on average 7.7 percent up on the same month last year. This price increase is higher than in the previous months.

Well that will cheer the European Central Bank or ECB. Indeed ECB President Lagarde may have a glass of champagne in response to this.

 In May 2020, house prices reached the highest level ever. Compared to the low in June 2013, house prices were up by 47.8 percent on average in that month.

Staying with the Netherlands and switching to the real economy we see this.

According to figures released by Statistics Netherlands (CBS), in April 2020 consumers spent 17.4 percent less than in April 2019. This is by far the largest contraction in domestic household consumption which has ever been recorded by CBS. Consumers mainly spent less on services, durable goods and motor fuels; on the other hand, they spent more on food, beverages and tobacco.

If we try to bring that up to date we see that if sentiment is any guide things have improved but are still weak.

At -27, the consumer confidence indicator in June stands far below its long-term average over the past two decades (-5). The indicator reached an all-time high (36) in January 2000 and an all-time low (-41) in March 2013.

Moving south to France we were told this earlier today.

In June 2020, the business climate has recovered very clearly, in connection with the acceleration of the lockdown exit. The indicator that synthesizes it, calculated from the responses of business managers from the main market sectors, has gained 18 points, its largest monthly increase since the start of the series (1980).

The jump is good news for the French economy although the rhetoric above does not match the detail.

At 78, the business climate has exceeded the low point reached in March 2009 (70), but remains far below its long-term average (100).

The situation is even worse for employment.

At 66, the employment climate still remains far below its May 2009 low (73), and, a fortiori, its long-term average (100).

Oh and staying with France I know some of you like to note these numbers.

At the end of Q1 2020, Maastricht’s debt reached €2,438.5 billion, a €58.4 billion increase in comparison to Q4 2019. It accounted for 101.2% of gross domestic product (GDP), 3.1 points higher than last quarter, the highest increase since Q2 2019.

Just as a reminder the UK measuring rod is different and tends to be around 4% of GDP lower. But of course both measures will be rising quickly in both France and the UK.

Comment

Let me now switch to a speech given earlier today by Philip Lane of the ECB.

 Euro area output contracted by a record 3.6 percent in the first quarter of the year and is projected to decline by a further 13 percent in the second quarter. While growth will partially rebound in the second half of this year, output is projected to return to the level prevailing at the end of 2019 only at the end of 2022.

In fact all of that is open to doubt as the first quarter numbers will be revised over time and as discussed above we do not know where we are right now. The forecasts are not realistic but manufactured to make other criteria such as the debt metrics look better than otherwise.

Also there is a real problem with the rhetoric below which is the cause of the policy change which was the Euro area economy slowing.

Thanks to the recalibration of our monetary policy measures announced in September 2019 – namely the cut in our deposit facility rate, enhanced forward guidance, the resumption of net asset purchases under the asset purchase programme (APP) and the easing of TLTRO III pricing – sizeable monetary accommodation was already in place when Europe was confronted with the COVID-19 shock.

As that was before this phase he is trying to hide the problem of having a gun from which nearly all the bullets have been fired. If we cut through the waffle what we are seeing are yet more banking subsidies.

The TLTRO programme complements our asset purchases and negative interest rate policy by ensuring the smooth transmission of the monetary policy stance through banks.

How much well here was @fwred last week.

ECB’s TLTRO-III.4 : €1308bn The Largest Longer Term Refinancing Operation ever………Banks look set to benefit, big time. All TLTRO-III will have an interest rate as low as -1% between Jun-20 and Jun-21, resulting in a gross transfer to banks of around €15bn. Most banks should qualify. Add tiering and here you are: from NIRP to a net transfer to banks!

So the banks get what they want which is interest-rate cuts to boost amongst other things their mortgage books which is going rather well in the Netherlands. Then when they overdose on negative interest-rates they are bailed out, unlike consumers and businesses. Another sign we live in a bankocracy.

Apparently the economy will win though says the judge,jury and er the defence and witness rather like in Blackadder.

An illustrative counterfactual exercise by ECB staff suggests that the TLTRO support in removing tail risk would be in the order of three percentage points of euro area real GDP growth in cumulative terms over 2020-22.

Austria

I nearly forgot to add that Austria is issuing another century bond today and yes I do mean 100 years. Even more extraordinary is that the yield looks set to be around 0.9%.

The Investing Channel

 

 

The Euro area has an inflation problem that the ECB ignores

Yesterday brought us up to date with the thoughts of ECB President Christine Lagarde as she gave evidence to the European Parliament, and grim reading and listening it made.

After a contraction in GDP of 3.8% in the first quarter of the year, our new staff projections see it shrinking by 13% in the second quarter. Despite being expected to bounce back later in the year and recover some of its lost ground, euro area real GDP is now projected to fall by 8.7% over the whole of 2020, followed by growth of 5.2% in 2021 and 3.3% in 2022.

The numbers for 2021 and 22 are pure fantasy of course an area where President Lagarde has quite a track record after her claims about Greece and Argentina. But the fundamental polnt here is of a large and in many ways unprecedented fall in this quarter.

Germany

We have received some hints this morning via the April trade figures for the Euro areas largest economy Germany.

WIESBADEN – Germany exported goods to the value of 75.7 billion euros and imported goods to the value of 72.2 billion euros in April 2020. Based on provisional data, the Federal Statistical Office (Destatis) also reports that exports decreased by 31.1% and imports by 21.6% in April 2020 year on year.

In a pandemic it is no surprise that trade is hit harder than economic output or GDP and the impact was severe.

That was the largest decline of exports in a month compared with the same month a year earlier since the introduction of foreign trade statistics in 1950. The last time German imports went down that much was in July 2009 during the financial crisis (-23.6%).

This meant that the German trade surplus which is essentially the Euro area one faded quite a bit.

The foreign trade balance showed a surplus of 3.5 billion euros in April 2020. That was the lowest export surplus shown for Germany since December 2000 (+1.7 billion euros). In April 2019, the surplus was 17.8 billion euros. In calendar and seasonally adjusted terms, the foreign trade balance recorded a surplus of 3.2 billion euros in April 2020.

In itself that is far from a crisis as both Germany and the Euro area have had plenty of surpluses in this area. But it will be a subtraction to GDP although some will be found elsewhere.

exports to the countries hit particularly hard by the corona virus pandemic dropped sharply from April 2019: France (-48.3%), Italy (-40.1%) and the United States (-35.8%).

So for the first 2 countries the falls will be gains although of course they will have their own losses.

There was a considerable decline in German imports from France (-37.3% to 3.5 billion euros) and Italy (-32.5% to 3.2 billion euros).

So we have a sharp impact on the economy although we need the caveat that these compete with retail sales to be the least reliable numbers we have.

Inflation

If we return to President Lagarde there was also this.

The sharp drop in economic activity is also leaving its mark on euro area inflation. Year-on-year HICP inflation declined further to 0.1% in May, mainly due to falling oil prices. Looking ahead, the inflation outlook has been revised downwards substantially over the entire projection horizon. In the baseline scenario, inflation is projected to average 0.3% in 2020, before rising slightly to 0.8% in 2021, and further to 1.3% in 2022.

There are serious problems with inflation measurement right now and let me explain them.

The HICP sub-indices are aggregated using weights reflecting the household consumption expenditure patterns of the previous year.

This is clearly an issue when expenditure patterns have changed so much. This is illustrated by the area highlighted by President Lagarde oil prices as we note automotive fuel demand was down 46.9% on a year ago. So she is being very misleading. Also I am regularly asked about imputed rent well it has plenty of company right now.

The second principle means that all sub-indices for the full ECOICOP structure will be compiled even when for some categories no products are available on the market. In such cases prices do not exist and they should be replaced with imputed prices.

So if you cannot get a price you make it up. You really could not er make it up…..

Also online quotes are used if necessary. That reflects reality but there is a catch as the prices are likely to be lower than store prices in more than a few cases.

What you might think are minor issues can turn into big ones as we saw last year from a rethink of the state of play concerning package holidays in Germany.

In the following years, the impact of the revision is smaller, between -0.2 and +0.3 p.p. Consequently, the euro area all-items annual rates are revised between 0.0 and +0.3 p.p. in 2015 and between -0.1 and +0.1 p.p. after.

Yes it did change the overall number for the Euro area which is I suppose a case f the mouse scaring and moving the elephant. This really matters when we are told this.

 the deteriorating inflation outlook threatening our medium-term price stability objective.

So we got this in response to a number which is dodgy to say the least.

The Governing Council last Thursday decided to increase the amount of the pandemic emergency purchase programme (PEPP) by an additional €600 billion to a total of €1,350 billion, to extend the net purchase horizon until at least the end of June 2021, and to reinvest maturing assets acquired under the programme until at least the end of 2022.

In context there is also this from Peter Schiff which raises a wry smile.

ECB Pres. Christine Lagarde claims that emergency action is necessary to protect Europeans from a mere 1.3% rise in their cost of living in the year 2022. Lagarde said such a small rise is inconsistent with the ECB’s goal of price stability. Prices must rise more to be stable.

George Orwell must wish he had put that in 1984, although to be fair his themes were spot on. He would have enjoyed how Christine Lagarde sets as her objective making people worse off.

The ECB measures will continue to be crucial in supporting the return of inflation towards our medium-term inflation aim after the worst of the crisis has passed and the euro area economy begins its journey to economic recovery.

Let’s face it even the (wo)man on Mars will probably be aware that these days wages do not necessarily grow faster than prices.

Comment

Let me now spin around to the real game in town for central bankers which is financial markets. Once they had helped the banks by letting them benefit from a -1% interest-rate which of course will in the end be paid by everyone else then boosting asset markets is the next game in town. I have already mentioned the large sums being invested to help governments borrow more cheaply with the 1.35 trillion. As a former finance minister Christine Lagarde can look forwards to being warmly welcomed at meetings with present finance ministers. After all Germany is being paid to borrow and even Italy only has a ten-year yield of 1.42% in spite of having debt metrics which are beginning to spiral.

Next comes equity markets where the Euro Stoxx 50 index was at one point yesterday some 1000 points higher than the 2386 of the 19th of March. The link from all the QE is of portfolio shifts as for example bonds providing less ( and in many cases negative income) make dividends from shares more attractive. As an aside this poses all sorts of risks from pensions investing in wrong areas.

But my main drive is that central banks can push asset prices higher but the problem is that the asset rich benefit but for everyone else there is them inflation. The inflation is conveniently ignored as those responsible for putting housing inflation in the numbers have been on a 20 year holiday. As even the ECB confesses that sector makes up a third of consumer spending you can see again how the numbers are misleading. Or to put it another way how the ordinary person is made worse off whilst the better off gain.

Christine Lagarde and the ECB have switched from monetary to fiscal policy

The Corona Virus pandemic has really rather caught the European Central Bank (ECB) on the hop. You see it was not supposed to be like this on several counts. Firstly the “Euro Boom” was supposed to continue but we now know via various revisions that things had turned down in Germany in early 2018 and then the Trumpian trade war hit as well. So the claims of former ECB President Mario Draghi that a combination of negative interest-rates and QE bond buying had boosted both Gross Domestic Product ( GDP) and inflation by around 1.5% morphed into this.

First, as regards the key ECB interest rates, we decided to lower the interest rate on the deposit facility by 10 basis points to -0.50%……..Second, the Governing Council decided to restart net purchases under its asset purchase programme (APP) at a monthly pace of €20 billion as from 1 November. We expect them to run for as long as necessary to reinforce the accommodative impact of our policy rates, and to end shortly before we start raising the key ECB interest rates.

As you can see the situation was quite problematic. For all the rhetoric who really believed that a cut in interest-rates of 0.1% would make a difference when much larger ones had not? Next comes the issue of having to restart sovereign bond purchases and QE only 9 months or so after stopping it. As a collective then there is the issue of what all the monetary easing has achieved? That leads to my critique that it is always a case of “More! More! More” or if you prefer QE to Infinity.

Next comes the issue of personnel. For all the talk about the ECB being independent the reclaiming of it by the political class was in process via the appointment of the former French Finance Minister Christine Lagarde as President. This of course added to the fact that the Vice President Luis de Guindos had been the Spanish Finance Minister. Combined with this comes the issue of competence as I recall Mario Draghi pointing out he would give Luis de Guindos a specific job when he found one he could do, thereby clearly implying he lacked the required knowledge and skill set. It is hard to know where to start with Christine Lagarde on this subject after her failures involving Greece and Argentina ( which sadly is in the mire again) and her conviction for negligence. Of course she has added to that more recently with her statement about “bond spreads” which saw the ten-year yield in Italy impersonate a Space-X rocket until somebody persuaded her to issue a correction. Although as the last press conference highlighted you never really escape a faux pas like that.

Do you now believe that it is the ECB’s role to control the spreads on government debt?

The Present Situation

This was supposed to be one where monetary policy had been set for the next year or so and President Lagarde could get her Hermes slippers under the table before having to do anything. Life sometimes comes at you quite fast though as this morning has already highlighted. From Eurostat.

In April 2020, the COVID-19 containment measures widely introduced by Member States again had a significant
impact on retail trade, as the seasonally adjusted volume of retail trade decreased by 11.7% in the euro area and
by 11.1% in the EU, compared with March 2020, according to estimates from Eurostat, the statistical office of
the European Union. In March 2020, the retail trade volume decreased by 11.1% in the euro area and by 10.1%
in the EU.
In April 2020 compared with April 2019, the calendar adjusted retail sales index decreased by 19.6% in the euro
area and by 18.0% in the EU.

As you can see Retail Sales have fallen by a fifth as far as we can tell ( normal measuring will be impossible right now and the numbers are erratic in normal times). Also there were large structural shifts with clothing and footwear down 63.5% on a year ago and online up 20.9%. Much of this is due to shops being closed and will be reversed but there is a loss for taxes and GDP which is an issue for ECB policy. Other news points out that May has its troubles as well.

Germany May New Car Registrations Total 168,148 -49.5% Y/Y – KBA ( @LiveSquawk)

Policy Response

For all the claims and rhetoric is that the ECB has prioritised the banks and government’s. So let us start with The Precious! The Precious!

Accordingly, the Governing Council decided today to further ease the conditions on our targeted longer-term refinancing operations (TLTRO III)……. Moreover, for counterparties whose eligible net lending reaches the lending performance threshold, the interest rate over the period from June 2020 to June 2021 will now be 50 basis points below the average deposit facility rate prevailing over the same period.

For newer readers this means that the banks will be facing what is both the lowest interest-rate seen so far anywhere at -1% and also a fix for the problems they have dealing with a -0.5% interest-rate more generally. It also means that whilst the bit below is not an outright lie it is also not true.

In addition, we decided to keep the key ECB interest rates unchanged.

In fact for those who regard the interest-rate for banks as key it is an untruth. Estimates for the gains to the banking sector from this are of the order of 3 billion Euros. Yet another subsidy or if you prefer we are getting the Vapors.

I’m turning Japanese, I think I’m turning Japanese, I really think so
Turning Japanese, I think I’m turning Japanese, I really think so

Fiscal Policy

This is what monetary policy has now morphed into. There is an irony here because one of the reasons the ECB has pursued such expansionary policy is the nature of fiscal policy in the Euro area. That has been highlighted in three main ways. the surpluses of Germany, the Stability and Growth Pact and the depressive policy applied to Greece. But that was then and this is now.

Chancellor Angela Merkel said Wednesday that Germany was set to plow 130 billion euros ($146 billion) into rebooting an economy severely hit by the coronavirus pandemic.

The measures include temporarily cutting value-added tax form 19% to 16%, providing families with an additional €300 per child and doubling a government-supported rebate on electric car purchases.

The package also establishes a €50 billion fund for addressing climate change, innovation and digitization within the German economy. ( dw.com )

Even Italy is being allowed to spend.

Fiat To Use State-Backed Loan To Pay Italy Staff, Suppliers ( @LiveSquawk)

This is the real reason for the QE and is highlighted below.

FRANKFURT (Reuters) – The European Central Bank scooped up all of Italy’s new debt in April and May but merely managed to keep borrowing costs for the indebted, virus-stricken country from rising, data showed on Tuesday.

The ECB bought 51.1 billion euros worth of Italian government bonds in the last two months compared with a net supply, as calculated by analysts at UniCredit, of 49 billion euros.

Comment

Thus President Lagarde will be mulling the words of Boz Scaggs.

(What can I do?)
Ooh, show me that I care
(What can I say?)
Hmmm, got to have your number baby
(What can I do?)

Plainly the ECB needs the flexibility of being able to expand its QE bond buying so that Euro area governments can borrow cheaply as highlighted by Italy or be paid to borrow like Germany. We could see the PEPP plan which is the latest emergency one expanded as it will run out in late September on present trends, also the German Constitutional Court has conveniently given it a bye. But she could do that next time. So finally we have a decision appropriate for a politician!

As to interest-rates we see that the banks have as usual been taken care of. That only leaves the rest of us so it is unlikely. We will only see another cut if they decide that like a First World War general that a futile gesture is needed.

The blue touch paper has been lit on the Money Supply boom of 2020

Today as I shall explain later is a case of back to the future especially for me. It brings an opportunity to examine one of the economic features of the current Covid-19 pandemic. This is a surge in money supply growth which has been quite something such that I think we will look back and consider it to be unprecedented. I expect that to be true in absolute terms in many places and it is already being true in relative terms in many.

The Euro Area

This morning has brought another signal of this so let us go straight to the ECB data.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, increased to 11.9% in April from 10.4% in March.

Previously we had eight months of growth of ~8% so as you can see going to 10.4% and then 11.9% shows that the accelerator has been pressed hard and maybe the pedal has been pushed to the metal. If we switch to the cause of this which is mostly the rate of QE purchases by the ECB well you can see below. Apologies for the alphabeti spaghetti.

ECB PSPP (EUR): +9.545B To 2.216T (prev +10.936B To 2.207T) –

CSPP: +1.181B To 213.147B (prev +2.324B To 211.966B) – CBPP: +1.028B To 280.778B (prev +1.030B To 279.750B) – ABSPP: -377M To 30.738B (prev +161M To 31.115B) –

PEPP: +30.072B To 211.858B (prev +28.878B To 181.786B) ( @LiveSquawk) ( B= Billion and T=Trillion )

These are the weekly increases and if we stick to the money supply we see that in one week alone some 42 billion Euros of QE took place which means that on the other side of the ledger the narrow money supply has been increased by the same amount. Some of this was previously taking place and the more recent boost is called PEPP and is of the order of 30 billion Euros a week.

What this means is that the total amount of narrow money has gone from just under 9 trillion Euros in January to just over 9.5 trillion in April and will be going past 10 trillion fairly soon ( at the current pace in July).

Tucked away in the detail is that people have been wanting cash as well. The amount in circulation rose by 25.6 billion Euros in March and by 15.1 billion in April. Only a couple of months but that represents a clear shift of gear as we note April was the same as the whole of the third quarter last year and 2020 so far has already exceeded 2019.

Broad Money

This is a case of the same old song.

Annual growth rate of broad >monetary aggregate M3 increased to 8.3% in April 2020 from 7.5% in March.

The pick-up in annual growth is of the order of 3% and this is the highest growth rate for nearly 12 years, well until next month anyway! Switching to totals it is now 13.6 trillion Euros.

The breakdown is rather revealing I think.

The annual growth rate of the broad monetary aggregate M3 increased to 8.3% in April 2020 from 7.5% in March, averaging 7.1% in the three months up to April. The components of M3 showed the following developments. The annual growth rate of the narrower aggregate M1, which comprises currency in circulation and overnight deposits, increased to 11.9% in April from 10.4% in March. The annual growth rate of short-term deposits other than overnight deposits (M2-M1) decreased to -0.3% in April from 0.0% in March, while the annual growth rate of marketable instruments (M3-M2) decreased to 6.7% in April from 10.1% in March.

This tells us a couple of things. The opener is that the expansion is a narrow money thing and in fact narrow money over explains it. That means that in terms of wider bank intermediation there was a credit contraction here as we shift from M1 to M3 via M2.

Also at first it looks like the rate of deposits from businesses has picked up but then we see it seems to be insurance companies and pension funds. Or if you prefer the ECB has just bought a load of bonds off them and they have deposited the cash for now.

From the perspective of the holding sectors of deposits in M3, the annual growth rate of deposits placed by households increased to 6.7% in April from 6.0% in March, while the annual growth rate of deposits placed by non-financial corporations increased to 13.7% in April from 9.7% in March. Finally, the annual growth rate of deposits placed by non-monetary financial corporations (excluding insurance corporations and pension funds) decreased to 12.3% in April from 16.9% in March.

Although that might seem obvious we have seen stages where it has not appeared to be true.

Credit

The credit punch bowl has been out too.

As regards the dynamics of credit, the annual growth rate of total credit to euro area residents increased to 4.9% in April 2020 from 3.6% in the previous month. The annual growth rate of credit to general government increased to 6.2% in April from 1.6% in March, while the annual growth rate of credit to the private sector increased to 4.4% in April from 4.2% in March.

The main thing of note here is the surge in credit given to governments which links to the increases in public expenditure we have seen. There has been quite a swing here as it was negative ( -2%) as recently as February and had been negative for 9 months. So the Stability and Growth Pact was applied and then abandoned.

Looking at the breakdown the fall in loans to households is presumably a decline in mortgage lending and I think you can all figure out why companies were borrowing more.

The annual growth rate of adjusted loans to the private sector (i.e. adjusted for loan sales, securitisation and notional cash pooling) stood at 4.9% in April, compared with 5.0% in March. Among the borrowing sectors, the annual growth rate of adjusted loans to households decreased to 3.0% in April from 3.4% in March, while the annual growth rate of adjusted loans to non-financial corporations increased to 6.6% in April from 5.5% in March.

@fwred of Bank Pictet has got his microscope out.

Wow, another massive increase in bank loans / credit lines to euro area corporates, up €73bn in April following €121bn in March (both the largest on record by a huge margin)…….Finally, the surge in bank loans in March-April was broad-based across countries. No one left behind.

His Euro area glass is always full so let me point out that there are times when companies are borrowing to invest (good) and times they are borrowing because they are in trouble.

Also he has been kind enough to illustrate one of my main themes so thank you Fred and the emphasis is mine

Euro area corporates are drawing on their credit lines and taking new bank loans like there *is* tomorrow.

Side-effect: most banks will easily qualify for the lowest TLTRO-III rate from June (-1%).

What a coincidence!

Comment

This is an example in a way of the circle of life as back in the day I got a job because as a graduate monetary economist City firms wanted people to look at the money supply. Although there was a difference in that the central banks and governments were trying to bring it down as opposed to pumping it up. Rather ominously it did not work as planned and sometimes did not work at all.

How should it work? In essence the extra money balances (narrow money) should be spent relatively quickly and thereby give the economy a boost. That is why I look at narrow money and as an indicator it has worked pretty well. The catch or “rub” as Shakespeare would put it is velocity or how quickly the money circulates and there we have a problem as it is hard to measure especially right now. We know that for a while it will have been extremely low because in many areas you simply cannot spend money at the moment.

As we look internationally we see many examples of this. I have gone through the Euro area data today but if we switch to the US the numbers are even higher. The annual rate of M1 growth is 27.5% there so the pedal may even have been pushed through the metal. Care is needed as definitions vary but even using a more Euro area one it looks as though it would be over 20%.

As well as some hoped for economic growth there is a clear and present danger which is inflation. We seem likely to be singing along with BB King.

Hey, Mr. President
All your congressmen too
You got me frustrated
And I don’t know what to do
I’m trying to make a living
I can’t save a cent
It takes all of my money
Just to eat and pay my rent

I got the blues
Got those inflation blues

The ECB hints at buying equities and replacing bank intermediation

A feature of this virus pandemic is the way that it seems to have infected central bankers with the impact of them becoming power mad as well as acting if they are on speed. Also they often seen lost in a land of confusion as this from yesterday from the Governor of the Bank of France highlights.

Naturally, there is a huge amount of uncertainty over how the economic environment will evolve, but this is probably less true for inflation.

Okay so the picture for inflation is clearer, how so?

 In the short term, the public health crisis is disinflationary, as exemplified by the drop in oil prices. Inflation is currently very low, at 0.3% in the euro area and 0.4% in France in April; granted, it is particularly tricky to measure prices in the wake of the lockdown, due to the low volume of data reporting and transactions, and the shift in consumer habits, temporary or otherwise.

This is not the best of starts as we see in fact that one price has fallen ( oil) but many others are much less clear due to the inability to measure them.Of course having applied so much monetary easing Francois Villeroy is desperate to justify it.

The medium-term consequences are more open to debate, due notably to uncertainties over production costs, linked for example to health and environmental standards and the potential onshoring of certain production lines; the differences between sectors could be significant, leading to variations in relative prices rather than a general upward path.

As you can see he moves from not being able to measure it to being very unsure although he later points out it is expected to be 1% next year which in his mind justifies his actions. There is the usual psychobabble about price stability being an inflation rate of 2% per annum which if course it isn’t.  #

Policy

It is probably best if you live in a glass house not to throw stones but nobody seems to have told Francois that.

Our choice at the ECB is more pragmatic: since March, we, like the Fed and the Bank of England, have greatly expanded and strengthened our armoury of instruments and in so doing refuted all those – and remember there were a lot of them only a few months ago – who feared that the central banks were “running out of ammunition”.

I will return to that later but let us move onto what Francois regards as longer-term policies.

First, in September 2019, we amended our use of negative rates with a tiering system to mitigate their adverse impacts on bank intermediation. I see no reason to change these rates now.

Actually it has not taken long for Francois to contradict himself on the ammunition point as “see no reason” means he feels he cannot go further into negative interest-rates for the general population. You may also note that he starts with “My Precious! My Precious!” which is revealing. Oh and he has cut the TLTRO interest-rate for banks to -1% more recently.

Plus.

Meanwhile, asset purchases, in operation since mid-2014, reached a total of EUR 2,800 billion in April 2020 and will continue at a monthly average pace of more than EUR 30 billion.

Make of this what you will.

We can also add forward guidance to this arsenal,….. This forward guidance provides considerable leeway to adapt to economic changes thanks to its self-stabilising endogenous component.

New Policy

Suddenly he did cut interest-rates and we are back to “My Precious! My Precious!”

The supply of liquidity to banks has been reinforced in terms of quantity and, above all, through an incentivising price structure. Interest rates on TLTROIII operations were cut dramatically on 12 March and again on 30 April and are now, at -1%

There is also this.

Above all, we have created the EUR 750 billion Pandemic Emergency Purchase Programme (PEPP)…….First, flexibility in terms of time. We are not bound by a monthly allocation…….Second, flexibility in terms of volume. Unlike the PSPP, we are not committed to a fixed amount – today, the PEPP can go “up to EUR 750 million”, and we stated on 30 April that we were prepared to go further if need be.

If we look at the weekly updates which have settled at around 30 billion Euros per week the original 750 billion will run out as September moves into October if that pace is maintained. So it looks likely that there will be more although as the summer progresses things will of course change quite a bit.

Then Francois displays even more of what we might call intellectual flexibility. You see he is not targeting spreads or “yield curve control” or a “spread control” but he is….

While there is a risk that the effects of the crisis may in some cases be asymmetric, we will not allow adverse market dynamics to lead to unwarranted interest rate hikes in some countries.

So he is trying to have his cake and eat it here.

Innovation

This word is a bit of a poisoned chalice as those have followed the Irish banking crisis will know. But let me switch to this subject and open with a big deal for the ECB especially since the sleeping giant known as the German Constitutional Court has shown signs of opening one eye, maybe.

And this brings me to my third point, flexibility in terms of allocation between countries.

He means Italy of course.

Next up is one of the sillier ideas around.

Allow me to say a final word on another development under discussion: the possibility of “going direct” to finance businesses without going through the bank channel. The truth is that we do this already, and have done since 2016, by being among the first central banks to buy corporate bonds.

He is probably keen because of this.

The NEU-CP market in Paris is by far the most active in the euro area, with outstandings of EUR 72 billion in mid-May, and the Banque de France’s most recent involvement since the end of March has been very effective and widely acknowledged by industry professionals.

Ah even better he has been able to give himself a slap on the back as well.

He is eyeing even more.

With its new Main Street Lending Program, the Fed recently went a step further by giving itself the possibility to fund the purchases of bank loans to businesses, via a special-purpose vehicle created with a US Treasury Department guarantee

If banks are bad, why are we subsidising them so much? Also why would central banks full of banks be any better?

After sillier let us have silliest.

ECB’s Villeroy: Would Not Put At Forefront Likelihood Of Buying Up Equities ( @LiveSquawk )

Comment

There is a familiar feel to this as we observe central bankers twisting and turning to justify where they find themselves. Let me start with something which in their own terms has been a basic failure.

This sluggishness in prices comes after a decade of persistently below-target inflation, which has averaged 1.3%.

This provides a range of contexts as of course the inflation picture would look very different if they made any real effort to measure  the one third or so of expenditure that goes on housing costs. In other areas this would be a scandal as imagine how ignoring a third of Covid-19 cases would be received? Also you might think that such failure after negative interest-rates and 2.8 billion Euros of QE might lead to a deeper rethink. This policy effort has in fact ended up really being about what was denied in this speech which is reducing bond yields so governments can borrow more cheaply. The hints in it have helped the ten-year yield in Italy fall to 1.55% as I type this.

Oh the subject of the ECB buying equities I am reminded that I suggested on the 2nd of March it would be next to make that leap of faith. I still think it is in the running however the German Constitutional Court may have slowed it up. The hint has helped the Euro Stoxx 50 go above 3000 today as equity markets continue to be pumped up on liquidity and promises. But more deeply we see that if we look at Japan what has been achieved by the equity buying? The rich have got richer but the economy has not seen any boost and in fact pre this crisis was in fact doing worse. So he is singing along with Bonnie Tyler.

I was lost in France
In the fields the birds were singing
I was lost in France
And the day was just beginning
As I stood there in the morning rain
I had a feeling I can’t explain
I was lost in France in love

 

Why are central bankers so afraid of the truth?

We find ourselves in an era where central bankers wield enormous power. There is something of an irony in this. They were given the ability to set monetary policy as a way of taking power out of the hands of politicians.This led to talk of “independence” as they set interest-rates to achieve an inflation target usually but not always of 2% per annum. Actually this is the first falsehood because we are regularly told this.

The ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%

They could also tell me the moon is full of cheese but I would not believe that either. I am amazed how rarely this is challenged but price stability is clearly an inflation rate of 0%, The usual argument that this stops relative price shifts collapsed when the oil price fall of 2015/16 gave us inflation of around 0% as plainly there was a relative price shift for oil and indeed other goods. Perhaps the shrieks of “Deflation” were a type of distraction.

Next has come the way that claimed independence has morphed into collusion with the political establishment. This moves us away from the original rationale which was to take monetary policy power out of the hands of politicians to stop them manipulating it for the electoral cycle. What had apparent success which was technocratic control of interest-rates has morphed into this.

  1. Interest-Rates around 0%
  2. Large-Scale purchases of sovereign bonds
  3. Large-Scale purchases of private-sector bonds
  4. Credit Easing
  5. Purchases of equities ( for monetary policy and as a consequence of exchange-rate policy)
  6. Purchases of commercial property so far via Exchange-Traded Funds or ETFs

Not all central banks have gone all the way down the list with the Bank of Japan being the leader of the pack and who knows may go even further overnight at its unscheduled meeting? I should add as people regularly look at my back catalogue that by the time anyone in that category reads this we may see many central banks at step 6 and maybe going further. But back to my collusion point here is some evidence.

I also confirm that the Asset Purchase Facility will remain in place for the financial year 2020-21.

This is almost a throwaway sentence in the inflation remit from the Bank of England but it is in fact extremely important in two ways, and in tune with today’s theme neither of which are mentioned. The Chancellor Rishi Sunak is reaffirming that Her Majesty’s Treasury is backing the QE ( Quantitative Easing ) policies of the Bank of England which currently are steps 2 to 4 above. Next comes the issue of the amount which is huge even for these times.

The Committee voted by a majority of 7-2 for the Bank of England to continue with the programme of £200 billion of UK government bond and sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, to take the total stock of these purchases to £645 billion.

The 2 dissenters voted for “More! More! More!” rather than less and I expect the extra £100 billion they voted for to be something sung about by The Undertones.

Happens all the time
Its going to happen – happen – till your change your mind
Its going to happen – happen – happens all the time

So we have a doom loop for supporters of independence as the politicians via backing any losses from QE become the masters again and the central bankers become marionettes. As so often we see Japan in the van by the way the Abenomics of Shinzo Abe appointed Governor Kuroda to the Bank of Japan pretty much as they would appoint a minister. It is the most exposed in terms of monetary policy via its 31.4 trillion Yen of equity holdings with a break-even it estimates at around 19,500 in terms of the Nikkei 225 index. Also of course an individual company in which it holds shares could fold.

Forward Guidance

This had a cacophony of falsehoods as we were promised interest-rate rises which failed to happen. In my own country it became laughable as an unemployment rate of 7% was highlighted and then unemployment rates of 6% and 5% were ignored. Then at Mansion House in June 2014 Governor Mark Carney said this.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming
more balanced.
It could happen sooner than markets currently expect.

In fact a bit over 2 years later he cut them whilst promising to reduce them further than November to 0.1% before economic reality even reached Threadneedle Street and the latter was redacted. It is hard to believe now but many were predicting interest-rate rises by the ECB in 2019 based on Forward Guidance. Of course the US Federal Reserve did actually give it a go before retreating like Napoleon from Moscow and as we recall the role of President Trump in this I would remind you of my political collusion/control point above.

Negative Interest-Rates

This area is littered with falsehoods. In Beatles terms it took only a week for this.

Bank of Japan Governor Haruhiko Kuroda said he is not thinking of adopting a negative interest rate policy now,

to become this.

The Bank will apply a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank.1 It will cut the interest rate further into negative territory if judged as necessary.

As Hard-Fi put it.

Can’t believe it
You’re so hard to beat
Hard to beat

The new Governor of the Bank of England seems to be on the same road to Damascus. From Sky News yesterday.

Mr Bailey told MPs it was now studying how effective that cut had been as well as “looking very carefully” at the experience of other countries where negative rates had been implemented.

On the prospect of negative rates, he said: “We do not rule things out as a matter of principle.

Curious because that is exactly what people had thought he had done several times in this crisis.

Comment

There are other areas I could highlight as for example there is the ridiculous adherence to the output gap philosophy that has proved to be consistent only in its failures. But let me leave you via the genius of Christine McVie the central bankers anthem.

Tell me lies
Tell me sweet little lies
Tell me lies, tell me, tell me lies
Oh, no, no, you can’t disguise
(You can’t disguise, no, you can’t disguise)
Tell me lies
Tell me sweet little lies

Me on The Investing Channel

 

Eurobonds To be? Or not to be?

We find that some topics have a habit of recurring mostly because they never get quite settled, at least not to everyone’s satisfaction. At the time however triumph is declared as we enter a new era until reality intervenes, often quite quickly. So last night’s Franco-German announcement after a virtual summit caught the newswires.

France and Germany are proposing a €500bn ($545bn; £448bn) European recovery fund to be distributed to EU countries worst affected by Covid-19.

In talks on Monday, French President Emmanuel Macron and German Chancellor Angela Merkel agreed that the funds should be provided as grants.

The proposal represents a significant shift in Mrs Merkel’s position.

Mr Macron said it was a major step forward and was “what the eurozone needs to remain united”. ( BBC)

Okay and there was also this reported by the BBC.

Mrs Merkel, who had previously rejected the idea of nations sharing debt, said the European Commission would raise money for the fund by borrowing on the markets, which would be repaid gradually from the EU’s overall budget.

There are a couple of familiar features here as we see politicians wanted to spend now and have future politicians ( i.e not them face the issues of paying for it). There is an undercut right now in that the choice of Frau Merkel reminds those of us who follow bond markets that Germany is being paid to borrow with even its thirty-year yield being -0.05%. So in essence the other countries want a slice of that pie as opposed to hearing this from Germany.

Money, it’s a crime
Share it fairly but don’t take a slice of my pie
Money, so they say
Is the root of all evil today
But if you ask for a raise it’s no surprise that they’re
Giving none away, away, away ( Pink Floyd)

Actually France is often paid to borrow as well ( ten-year yield is -0.04%) but even it must be looking rather jealously at Germany.Here is how Katya Adler of the BBC summarised its significance.

Chancellor Merkel has conceded a lot. She openly agreed with the French that any money from this fund, allocated to a needy EU country, should be a grant, not a loan. Importantly, this means not increasing the debts of economies already weak before the pandemic.

President Macron gave ground, too. He had wanted a huge fund of a trillion or more euros. But a trillion euros of grants was probably too much for Mrs Merkel to swallow on behalf of fellow German taxpayers.

She has made a technical error, however, as Eurostat tends to allocate such borrowing to each country on the grounds of its ECB capital share. So lower borrowing for say Italy but not necessarily zero.

The ECB

Its President Christine Lagarde was quickly in the press.

So there is zero risk to the euro?

Yes. And I would remind you that the euro is irreversible, it’s written in the EU Treaty.

Of course history is a long list of treaties which have been reversed. Also there was the standard tactic when challenged on debt which is whataboutery.

Every country in the world is seeing its debt level increase – according to the IMF’s projections, the debt level of the United States will reach more than 130% of GDP by the end of this year, while the euro area’s debt will be below 100% of GDP.

Actually by trying to be clever there, she has stepped on something of a land mine. Let me hand you over to the French Finance Minister.

French Finance Minister Bruno Le Maire said on Tuesday, the European Union (EU) recovery fund probably will not be available until 2021.

The 500 bln euro recovery fund idea is a historic step because it finances budget spending through debt, he added. ( FXStreet )

So the height of the pandemic and the economic collapse will be over before it starts? That is an issue which has dogged the Euro area response to not only this crisis but the Greek and wider Euro area one too. It is very slow moving and in the case of Greece by the time it upped its game we had seen the claimed 2% per annum economic growth morph into around a 10% decline meaning the boat had sailed. In economic policy there is always the issue of timing and in this instance whatever you think of the details of US policy for instance it has got on with it quickly which matters in a crisis.

Speaking of shooting yourself in the foot there was also this.

Growth levels and prevailing interest rates should be taken into account, as these are the two key elements.

The latter is true and as I pointed out earlier is a strength for many Euro area countries but the former has been quite a problem. Unless we see a marked change we can only expect the same poor to average performance going ahead. Mind you we did see a hint that her predecessor had played something of a Jedi Mind Trick on financial markets.

Outright Monetary Transactions, or OMTs, are an important instrument in the European toolbox, but they were designed for the 2011-12 crisis, which was very different from this one. I don’t think it is the tool that would be best suited to tackling the economic consequences of the public health crisis created by COVID-19.

They had success without ever being used.

Market Response

Things have gone rather well so far. The Euro has rallied versus the US Dollar towards 1.10 although it has dipped against the UK Pound. Bond markets are more clear cut with the Italian bond future rising over a point and a half to above 140 reducing its ten-year yield to 1.62%. The ten-year yield in Spain has fallen to 0.7% as well. It seems a bit harsh to include Spain after the economic growth spurt we have seen but nonetheless maybe it did not reach escape velocity.

Comment

Actually there already are some Eurobonds in that the ESM ( European Stability Mechanism) has issued bonds in the assistance programmes for Greece, Italy, Portugal and Spain. Although they were secondary market moves mostly allowing countries to borrow more cheaply rather than spend more. On that subject I guess life can sometimes come at you fast as how is this going?

Taking into account these measures, the
government remains committed to meeting the
primary fiscal surplus for 2020 and forecasts a
primary surplus at  3.6% of GDP ( Greece Debt Office)

On the other side of the coin it will be grateful for this.

81% of the debt stock is held by official sector creditors,
allowing for long term maturity profile and low interest
rates

On a Greek style scale the 500 billion Euros is significant but now we switch to Italy we see that suddenly the same sum of money shrinks a lot. I notice that Five Star ( political party not the band) have already been on the case.

It’s just too little, too late
A little too long
And I can’t wait ( JoJo)

This brings me to the two real issues here of which the first is generic. In its history fiscal policy finds that it can not respond quickly enough which is why the “first responder” is monetary policy. The problem is that the ECB has done this so much it is struggling to do much more and the European Union is always slow to use fiscal policy. Such as it has then the use has been in the other direction via the Stability and Growth Pact.

Next comes the fact that there are 19 national treasuries to deal with for the Euro and 27 for the European Union as I note that last night’s deal was between only 2 of them. Perhaps the most important ones but only 2.

The central banking parade continues

The last 24 hours have seen a flurry of open mouth operations from the world’s central bankers. There are a couple of reasons for this of which the first is that having burst into action with the speed of Usain Bolt they now have little to do. The second is that they have become like politicians as they bask centre stage in the media spotlight. The third is that their policies require a lot of explaining because they never achieve what they claim so we see long words like “counterfactual” employed to confuse the unwary.

The land of the rising sun

Let us go in a type of reverse order as Governor Kuroda of the Bank of Japan has been speaking this morning and as usual has uttered some gems.

BoJ Gov Kuroda: Repeats BoJ Would Not Hesitate To Add Additional Easing If Needed -BoJ Has Several Tools And Measures To Deploy If Required ( @LiveSquawk )

This is something of a hardy perennial from him the catch though comes with the “if required” bit. You see the April Economic Report from the Ministry of Finance told us this.

The Japanese economy is getting worse rapidly in an extremely severe situation, due to the Novel Coronavirus…….Concerning short-term prospects, an extremely severe situation is expected to remain due to the influence of the infectious disease. Moreover, full attention should be given to the further downside risks to the domestic and foreign economy which are affected by the influence of the infectious disease.

So if not now when? After all the Japanese economy was already in trouble at the end if 2019 as it shrank by 1.8% in the final quarter. Actually he did kind of admit that.

BoJ’s Kuroda: Japan’s Economy To Be Substantially Depressed In Q2

Then looking at his speech another warning Klaxon was triggered.

In the meantime, it expects short- and long-term policy interest rates to remain at their present
or lower levels.

This raises a wry smile because in many ways the Bank of Japan is the central bank that likes negative interest-rates the least. Yes it has one of -0.1% but it tiptoed into it with the minimum it felt it could and stopped, unlike in other easing areas where it has been happy to be the leader of the pack. Why? Well after nearly 30 years of the lost decade it still worries about the banking sector and whether it could survive them and gives them subsidies back as it is. Frankly it has been an utter disaster and shows one of the weaknesses of the Japanese face culture.

Oh and as we mull the couple of decades of easing we got this as well.

KURODA: RECENT EASING ACTION INCLUDING MORE ETF PURCHASES IS TEMPORARY ( @DeltaOne)

This morning there was just over another 100 billion Yen of equity ETF purchases as we mull another refinement of the definition of temporary in my financial lexicon for these times. It appears to mean something which keeps being increased and never ends.

The Bank of England

The new Governor Andrew Bailey gave an interview to Robert Peston of ITV last night which begged a few questions. The first was how its diversity plans seem to involve so much dealing with the children of peers of the realm and Barons in particular? This of course went disastrously wrong with Deputy Governor Charlotte Hogg who seemed to know as little about monetary policy as she did about the conflict of interest issue which led to her departure. During the interview Robert Peston seemed to be exhibiting a similar degree of competence as I pointed out on social media.

@Peston  now says that buying hundreds of billions of debt is different to a decade ago when the Bank of England bought er hundreds of billions of debt. It is frightening that this man was once BBC economics editor.

There was a policy element although it was not news to us I am sure it was to some.

Governor of the Bank of England Andrew Bailey has told ITV’s Peston show that one of the main purposes of the Bank buying £200bn of government debt – and probably more over the course of the Covid-19 crisis – is to “spread the cost of this thing to society” and help the government avoid a return to austerity. ( ITV)

To the extent that there was a policy announcement the whole interview was very wrong as it should be on the Bank of England website for all to see rather than boosting the career of one journalist and network. As I note how that person’s career had been under pressure we see the UK establishment in action. I also note that two subjects were not mentioned.

  1. The apparent dirty protest at the FCA on Andrew Bailey’s watch
  2. The doubling of overdraft interest-rates after a botched intervention by the FCA on Andrew Bailey’s watch.

The United States

Something rather ominous happened last night as The Hill reports.

“He has done a very good job over the last couple of months, I have to tell you that,” Trump told reporters during a meeting with the governors of Colorado and North Dakota. “Because I have been critical, but in many ways I call him my ‘MIP.’ Do you know what an MIP is? Most improved player. It’s called the Most Improved Player award.”

We noted back in November 2018 that The Donald was taking charge of US monetary policy and that Jerome Powell had become something of a toy. Indeed there was more.

The president said he still is at odds with Powell over his stance on negative interest rates. Trump has for months pushed negative interest rates, arguing the U.S. is on an unfair playing field if other countries have negative rates.

Whilst I disagree with The Donald on negative interest-rates he is at least honest and we know where he stands. Whereas Chair Powell said this.

Speaking to the Peterson Institute for International Economics, Powell said negative interest rates are “not something that we’re looking at,” ( Forbes)

Is that an official denial? Anyway it does not go that well with this.

The economic toll has taken an outsized toll on lower-income households, Powell said, with 40% of those employed in February and living in a household that makes less than $40,000 a year losing their job in March.

Conceptually this is a real issue for the US Federal Reserve as such people are unlikely to have many holdings ( or indeed any…) of the assets it keeps pumping up the price of.

Comment

As we survey the scene some of it is surreal. I noted on Tuesday that the US had already seen two examples of negative interest-rates and one has deepened in the meantime. US Feds Funds futures have moved as high as 100.025 for the summer of 2021 and 100.05 for the autumn. Now -0.05% is not a lot but these things have a habit of being like a balloon that is about to be inflated.

You may also note that those who have claimed central banks are independent of government have been silent recently.Perhaps they are busy redacting past comments?

Missing for today’s update so far has been the European Central Bank or ECB. This is because it is involved in something of an internal turf war.

The shock at the ruling is palpable in the corridors of power in Berlin as Karlsruhe’s three-month deadline runs down.

Officials are trying to work out a way of satisfying the court without eroding the independence of the ECB, which has kept the euro zone intact through a decade of crises.

One lawmaker described feeling like a bomb disposal expert, “because the Constitutional Court has put an explosive charge under the euro and the EU”. ( Reuters)

Hang on! Someone still thinks central banks are independent…….