Should the ECB be reformed and how?

This morning has brought an intriguing opinion piece in the Alphaville section of the Financial Times. It concerns the European Central Bank and comes from what you might call a classic insider as the header suggests.

Lorenzo Bini Smaghi, Société Générale chairman, Project Associate at the Harvard Kennedy School’s Belfer Center for Science and International Affairs, and Senior Fellow at LUISS School of European Political Economy in Rome.

This covers a lot of ground as after all shouldn’t  being chairman of Societe Generale be a full-time job? This dichotomy where lower jobs are full-time but more senior ones are not seems to be ever more common. With a share price less than a quarter of what it was at its peak and furthermore it being down 25% over the past year you might think directors would be fully employed trying to make things better. Of course we are invariably told that such people can have so many roles because they are so capable and intelligent which of course then begs the question of how we are where we are?

For some reason the Financial Times header was a little forgetful of the fact that Mr Bini Smaghi was an Executive Board member of the ECB for six years from 2005. This matters as it is likely that he is being used like a weather vane, so let us take a look.

The Inflation Target

Here is the opening salvo, with which regular readers will be familiar.

The ECB’s primary objective is price stability, defined as “a rate of inflation below but close to 2 per cent”. The average inflation rate over the 20 years of the euro has been 1.7 per cent, which may suggest success.

Now even your average Martian will be aware that the last decade has not been a success but look what Lorenzo picks out.

However, the result has been less satisfactory (a dalliance with deflation) in more recent periods.

This focusing on deflation is misleading for several reasons. Firstly he is deliberately equating falling prices or disinflation with shrinking aggregate demand or deflation. This matters because Lorenzo’s “deflation” was essentially the result of a lower oil price as I pointed out at the time. Also rather than a problem, at a time of restricted wage growth lower and indeed negative inflation provides an economic boost via its positive impact on real wages. I pointed this out back on the 29th of January 2015.

However if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly.

Thus Lorenzo is flying something of a false flag here and is an example of what I predicted back then.

 If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.

You will not be surprised to find that the suggestion is a loosening of the target as seen below.

 Furthermore, research shows that the ECB’s policy decisions over the years anyway reflect a symmetric interpretation of the target around 2 per cent. So why not move to such a target? It would at least be more transparent.

This matters even more if we note that in spite of the negative interest-rates and the QE inspired balance sheet expansion the ECB has in its own terms not yet achieved its target. This is because whilst inflation is above 2% at 2.1% of that some 0.8% is energy costs which are mostly outside its control. Putting it another way it is remarkable how little consumer inflation has been created by so much monetary easing. In fact with it so low we have to question whether it also has disinflationary influences not predicted by economics 101.

Thus even what seems a minor reshuffling of the target would if we remain in a similar situation to now lead to the possibility of a large policy change. We could get QE to its current maximum in terms of Euro area sovereign bonds where they are bought up to the limit imposed by the German bond market. In a way it all comes from this misrepresentation or lie.

 reconsider the definition of price stability.

Price stability would be 0% not 2% per annum. In response my suggestion would be to lower the Euro area inflation target to either 1.5% or 1%.

Signals

The next bit is even odder.

The two pillars are analysis of economic and monetary data, but the latter — money and credit aggregates — have proved over time to be unreliable predictors of inflationary pressures……….. In July 2008, for instance, the resilient fast pace of credit growth justified the rate hike which was made, even as the real economy had started to show signs of a slowdown

Actually if we look at annual M1 growth which is the leading indicator for monetary data the annual rate of growth had fallen from 11.7% in December 2005 to 0.1% in July 2008. So the truth is that the ECB simply looked at (backwards-looking) credit growth rather than the clear signal from M1. Actually, looking at like that the series without seasonal adjustment could hardly be much clearer.

Collateral

As you can imagine our bank chairman is not keen on the way countries can be excluded from this. After all who will think of the banks holding their debt? Here is his proposed solution.

Consideration should be given to return to a system based on progressive haircuts.

Share risk, as well as supervision

This would have the Starship Enterprise on yellow if not red alert. This is the current state of play.

Banks that are solvent, but do not have adequate collateral, may require the central bank to act as a so-called “lender of last resort”. That function for banks is still decentralized, with the national central banks bearing the risks.

So if an Italian bank were to fail it is the responsibility of the Bank of Italy to step in. Whereas Lorenzo wants this.

In particular, if the decision on whether a bank is solvent and is eligible to emergency lending is centralized, the risk for such lending should be shared.

So in this new universe the ECB would be responsible and not the Bank of Italy as the federal web gets more steel and perhaps titanium. The issue of being “solvent” is usually a red herring as central banks seem to find the most disastrous business models as being viable.

Exit Troika, stage left

Nobody seems to have told Lorenzo about the nomenclature change to “The Institutions”, but of course bankers often struggle with current events. Anyway it is hard to disagree with the thrust here, frankly who would want to be a member of it?

Remaining a member of the Troika is now less justified, and the unpopularity of adjustment programmes tends to erode the ECB’s reputation and independence.

Let somebody else take the blame!

Comment

The good news is the implied view that the ECB needs reform. Sadly the predictable part is that it heads in a direction which has so far caused more trouble than it has solved. For those who believe that the Euro establishment want crises so that they can present what they wanted to achieve anyway as part of the crisis resolution there is another tick in that box. My suggestion would be for a much more root and branch reform of central banking. For example inflation control has morphed into inflation creation or in consumer inflation terms attempted inflation control. Plus of course a boost for those who own assets.

However it is also true that the ECB has been left exposed and in the cold by the Euro establishment. The lack of any political response in terms of economic policy to the credit crunch left it and monetary policy with far too much to do. It has overplayed its hand in response, and must now fear heading into the next downturn with its foot still pressing down on the accelerator. At least it managed to shuffle its holdings of Greek debt largely to another Euro area body but that process and its insistence on full repayment added to the crisis at its height.

Heading forwards I would have two main suggestions.

  1. Lower the inflation target
  2. Much more questioning of what QE actually achieves.
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What is happening to the economy of Germany?

This morning has brought news which will bring a smile of satisfaction to the central bankers at the ECB (European Central Bank). From the German statistics office.

The harmonised index of consumer prices (HICP) for Germany, which is calculated for European purposes, rose by 2.2% in September 2018 on September 2017. Compared with August 2018, the HICP increased by 0.4% in September 2018.

All the ECB’s efforts have got German inflation pretty much to where they want it to be. It has been quite an effort as the official deposit rate is still -0.4% and there are still around US $1.5 trillion of bonds with a negative yield in the Euro area. But we are near to the target and the extra 0.2% can be responded to by pointing out that the amount of monthly QE is on its way to zero.

The ordinary German consumer and worker may not be quite so keen as items downgraded to non-core by central bankers are important to them.

 Energy prices rose 7.7% in September 2018 on September 2017. The rate of energy price increase thus increased again (August 2018: +6.9%). ………Food prices rose above average (+2.8%) from September 2017 to September 2018. The year-on-year price increase thus accelerated slightly in September 2018 ( August 2018: +2.5%).  ( From the German CPI detail)

Indeed they may be wondering how to translate ” I cannot eat an I-Pad” into German?

Consumers benefited, among other things, of lower prices of telephones (-5.3%) and consumer electronics (-4.6%).

Those who think that rents are related to real wage growth will get a little food for thought from this.

 A major factor contributing to the increase in service prices was the development of net rents exclusive of heating expenses (+1.5%), as households spend a large part of their consumption expenditure on this item.

Travelling through the detail shows us that whilst the aggregate looks good in fact the inflation numbers have only moved to around the target level because of energy costs. All that monetary easing had little effect on consumer inflation but of course saw large wealth gains for those holding assets and subsidised government borrowing costs.

Asset Prices

This has been an area of satisfaction for the central banker play book as we note that in the first two quarters of 2018 house prices rose at an annual rate of 5.5% and 4.7%. The index set at 100 in 2015 has reached 115.1. So a win double for the establishment as it can claim wealth effects of between 4% and 5% whilst as we have observed above tell the ordinary person that via the use of fantasy imputed rents inflation in this area is only 1.5%.

Although as DW pointed out in May last year not even every central banker is a believer.

Bundesbank warns of German real estate bubble

Why might this be?

Due to mortgage interest rates of well below two percent, Germany has been experiencing a rapid transition towards home ownership in recent years, now creating fears familiar in many other property markets. Housing prices, which were relatively cheap compared with other European countries in the past, have risen sharply.

Real estate prices in cities like Berlin, Hamburg, Munich and Frankfurt have increased by more than 60 percent since 2010, according to recent estimates by the German central bank, the Bundesbank.

We look from time to time for examples of mortgage rates and DW provided us with one.

Commerzbank, the country’s second-largest lender, offers a mortgage with an ultra-cheap fixed rate of just 0.94 percent for a 10-year loan.

It is hard to over emphasise how extraordinary that is! Also should it carry on it may lead to quite a change in the structure of German life.

For many well-off Germans with permanent jobs renting no longer makes sense.

Since then house prices have continued to rise.

Economic growth

As recently as the middle of June the German Bundesbank was very upbeat.

Germany’s economic boom will continue. The already high level of capacity utilisation in the economy will increase up until 2020,

Although hang on.

although growth is unlikely to be quite as strong as in 2017. Growth in exports and business investment will be less strong. In addition, the rising shortage of skilled workers will increasingly dampen employment growth.

Indeed as we look at the specifics frankly it does not look much of a boom to me.

Against this backdrop, the Bundesbank‘s economists expect calendar-adjusted economic growth of 2.0% this year and 1.9% next year. In 2020, real gross domestic product (GDP) could increase by 1.6% in calendar-adjusted terms.

If we apply the rule that has been suggested in the comments on here that official economic growth needs to be 2% per annum for people to feel it then Germany may even be slipping backwards. This week as MarketWatch points out below has seen others fall in line with this growth but perhaps not as we know it scenario.

Germany’s economic growth is now expected to come in at 1.8% this year, rather than the 2.3% forecast previously, the government said Thursday in its autumn report. Next year’s expansion is now seen at 1.8% instead of 2.1%……..Earlier this week, the International Monetary Fund cut its growth forecasts for Germany to 1.9% for both this year and the next, decreases of 0.3 and 0.2 percentage points respectively.

We can bring this up to date by noting the industrial production figures released today by Eurostat. These show a flatlining in August meaning that the annual figure had declined by 0.5%.

Comment

After a good spell for the German economy ( which expanded by 2.2% in 2017) we are starting to wonder if that was as good as it gets? Regular readers will be aware of the way that money supply growth has been fading in the Euro area over the past year or so, and thus will not be surprised to see official forecasts of a boom if not fading to dust being more sanguine. As the money supply changes have as a major factor the fading of ECB QE we return to the theme of Euro area economies being monetary junkies which perhaps Mario Draghi has confirmed this morning.

*DRAGHI: SIGNIFICANT MONETARY POLICY STIMULUS IS STILL NEEDED

After all we are in official parlance still in a broad-based expansion. Moving back to Germany it is starting a little bit to feel like what happened to high streets when they lost individuality and became clones. Some economic growth accompanied by asset price rises whilst official inflation rises by less than you might have thought.Or the equivalent of finding Starbucks and various estate agents on every high street,or putting it another way look at this from the Bundesbank.

German economic growth will therefore consistently outstrip potential output growth,

Yes even the sub 2% economic growth is apparently too much just like most of us in Europe. One can go too far of course as there are the surpluses to consider in trade and government finances. The former was supposed to be something that was going to be dealt with post credit crunch but by now you know the familiar and some might think never-ending story. Sometimes life feels a bit like this experience for a City-AM journalist.

Hey . How am I meant to log into my account to report my lost phone when the login process requires sending a text to my phone?

As has been pointed out the concept of Catch-22 has reached Milennials. Let me leave you with something for the weekend which believe it or not is to promote Frankfurt.

 

 

The Italian job just got a whole lot harder

The last few days have brought back memories of old times as an old stomping ground has returned to the forefront of financial news. This has been the Italian bond market which has been since Friday morning a real life example of the trading phrase “Don’t try to catch a falling piano”, or in some cases knife. If we look at the Italian bond future it has fallen 6 points since late on Thursday from a bit above 127 to a bit above 121. For these times a 2 point a day drop in a bond market is quite a bit especially when we consider that one large holder will not be selling. That is of course the European Central Bank or ECB which as of the 21st of September had bought some 356.4 billion Euros of them. So we note as an initial point that  falls of this magnitude, which has been on average the old price limit for US Treasury Bond futures ( a 2 point move led to a temporary trading stop back in the day) can happen even in the QE era.

Putting this another way the yield on the Italian ten-year benchmark bond has risen to 3.4%. This means that if we look at the deposit rate of the ECB which is -0.4% there is quite a yield curve here. It starts early with for those who have been invested here quite a chilling thought. You see as recently as mid may the Italian two-year yield was negative ( last December it was -0.36%) whereas at the time of typing this it is 1.56%. So those long have had a disaster although of course they can hold the bond to maturity and just lose the yield. Although of course we would not be here if there were not at least the beginnings of fears over the maturity itself such as perhaps you not being paid in Euros. From @DailyFXTeam.

EUR Borghi comments on the desirability of Italy having its own currency push Italian 10-yr yields to 3.4%, highest since March, 2014

Claudio Borghi is the chief adviser to Matteo Salvini who is Deputy Prime Minister and has been upping the rhetoric himself this morning. Via Twitters translation service.

In Italy No one is drinking the threats of Juncker, which now associates our country with Greece.

Madness they call it madness

There has been plenty of this including this curious statement yesterday from Matteo Salvini.

*ITALY’S SALVINI SAYS `GENTLEMEN OF THE SPREAD’ WILL UNDERSTAND

If we bypass the obvious sexism he is referring to the yield spread between Italian bonds and the benchmark for the Euro area which is of course Germany. A part of the Euro project is that these should converge over time as economies also converge. Except we have seen quite a divergence recently as if we look at the ten-year gap this morning it reached 3% per annum, which if you held to maturity would be a tidy sum especially if this fantasy came true.

Borghi advocating an ECB enforced max spread to Germany of 150bps. ( h/t @stewhampton )

In recent times it would appear that the ECB has been the main buyer of BTPs but it as of this week has reduced again its purchases and will buy around 1.7 billion Euros only in October. As we stand it seems unlikely to fire up its QE programme just for Italy. It did buy Italian bonds back at the peak of the Euro area crisis but bond yields were more than double what they are now.

The Deficit

In the grand scheme of things the change here has been quite minor. From Reuters.

Italy new eurosceptic government proposed on Thursday a budget that increases the deficit to 2.4 percent of gross domestic product in 2019, tripling it in comparison with the plans of its predecessors.

Actually the real change has been from 1.8% of GDP as rumoured just over a week ago, as we find that 0.6% of GDP has turned out to be the straw that broke the camel’s back. Actually the real switch in my opinion is not to be found here but rather in the implications for the national debt.

Under EU law Italy should reduce its public debt rather than increase borrowing. Rome’s total debt is worth 133 percent of GDP.

Just as a reminder the Euro area limit is supposed to be 60% of GDP. Thus Italy is supposed to be reducing its ratio but we know that it has been increasing it over the credit crunch era. Should the higher bond yields last then they will put further upwards pressure on it and in some respects Italy will start to look a little like Greece.

The economy

This is the crux of the matter as the most revealing point is that the budget forecast relies on Italy growing at 1.6% or 1.7% next year. The catch for those who have not followed its economic trajectory is that it only grows at about 1% in the good years and has had a dreadful credit crunch era. Those who were cheerleaders for the “Renzinomics” of around 2014 need to eat more than one slice of humble pie as it never happened. Yesterday brought another same as it ever was signal.

Manufacturing operating conditions in Italy stagnated during September as output and new orders both fell marginally. Job creation was sustained, but at a much slower rate as signs of spare capacity persisted………September’s data also marked the first time in just over two years that the sector has failed to expand.
Manufacturing output fell in September. Although negligible, the decline in production marked a second successive monthly contraction in line with a similar development for new orders.

If we switch to the official monthly economic report it too is downbeat.

In August, both consumer confidence and the composite business indicator declined, influenced respectively by the worsening of economic expectations and the climate in manufacturing sector, which is further affected by the
decline in book orders and expectations on production.

So we see that Italy which grew by 0.5% in the first half of the year will do well to repeat that in the second half especially if we note the slowing of the Euro area money supply we looked at last Thursday.

Much better news came from the labour market.

In August 2018, 23.369 million persons were employed, +0.3% over July. Unemployed were 2.522 million,
-4.5% over the previous month……..Employment rate was 59.0%, +0.2 percentage points over the previous month, unemployment rate was 9.7%, -0.4 percentage points over July 2018 and inactivity rate was 34.5%, +0.1 points over the previous month.

Let us hope that is true as Italy badly needs some good economic news, but it has developed a habit of declaring such numbers and then revising them higher later. Also it remains a bad time to be young in Italy.

Youth unemployment rate (aged 15-24) was 31.0%, +0.2 percentage points over the previous month

Comment

The situation here is something which has been changed by some rather small developments. Why? Well it is a consequence of my “Girlfriend in a Coma” theme which I have been running for some years now. When you grow by so little in the good times you are left vulnerable to changes, and hence apparently small ones can cause trouble. This has been added to by the frankly silly rhetoric on both sides.

Added to this is the issue of the consequences of the QE era which has been a subject over the past couple of weeks. Italy tucked itself under the “Whatever it takes” umbrella of President Draghi of the ECB but has not reformed much if at all so as the umbrella gets folded up and put away it is vulnerable again. Since that speech was given in the summer of 2012 the Italian economy has grown by a bit over 2% and is still some 4-5% smaller than it was a decade ago. This is the real Girlfriend in a coma issue which has led to the problems with the banks and the national debt and has given us the Italian version of a lost decade. As the population has been growing the individual experience has been even worse than that.

The other way that Italy is different to Greece is that in Euro terms it is indeed systemic due to its much larger size.

 

 

 

 

Slowing money supply growth puts the ECB between a rock and a hard place

Sometimes life is awkward and this morning is an example of that for the central bankers of the Euro area at the European Central Bank or ECB. Let me open with the hard place which is a development we have been following closely in 2018 and comes direct from the ECB Towers.

The annual growth rate of the broad monetary aggregate M3 decreased to 3.5% in August 2018 from 4.0% in July, averaging 4.0% in the three months up to August.

This matters because if we look forwards the rule of thumb is that it represents the sum of economic growth and inflation. So we initially see that something of a squeeze is on. In fact it has been one of the guiding variables for ECB policy. Let me give you an example of this from the January press conference where Mario Draghi told us this.

Turning to the monetary analysis, broad money (M3) continues to expand at a robust pace, with an annual rate of growth of 4.9% in November 2017, after 5.0% in October, reflecting the impact of the ECB’s monetary policy measures and the low opportunity cost of holding the most liquid deposits.

Back then the garden looked rosy with the Euroboom apparently still continuing. But in the April press conference Mario Draghi had gone from bullish to nervous.

 It’s quite clear that since our last meeting, broadly all countries experienced, to different extents of course, some moderation in growth or some loss of momentum. When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

He did not specifically refer to the money supply data but we now know that in March the rate of M3 growth had fallen to 3.7% and that whilst he may not have had all the data warning signs would be there. In such circumstances always look for what they do not tell you about!

Since then the numbers have fluctuated somewhat as it their want but the trend is clear as they sing along to “Fallin'” by Alicia Keys. The big picture is that the 5.3% of March 2018 has been replaced by 3.5% now.

The Rock

This for the ECB is its inflation target as it is one of the central banks who really do try very hard to achieve it as opposed to the lip-service of say the Bank of England. I still recall Jean-Claude Trichet defining it as 1.97% in his valedictory speech, and whilst that contains some spurious accuracy you get the idea. So in a sense what we now have are happy days.

The euro area annual inflation rate was 2.0% in August 2018, down from 2.1% in July 2018. A year earlier, the rate
was 1.5%.

Except if you take my rule of thumb above and in a broad sweep the amount left over for economic growth has gone from ~3.5% to more like 1.5%. This morning has brought news which suggests the inflation collar may be getting a little tighter. We do not get the overall number for Germany until later today but the individual lander have been reporting higher numbers with Bavaria leading the charge at 0.5% monthly and 2.5% annually for its CPI. However we do now have what appears to be a leaked number as @fwred explains.

Yep, German CPI apparently leaked early once again . 0.4% MoM consistent with strong regional data, would push inflation rate to 2.3-2.4% YoY, way above expectations.

As the largest economy in the Euro area that will pull inflation higher directly and of course there is also the implicit influence that many inflation trends will be international within the shared currency. Returning to my rule of thumb there is even less scope for economic growth if this is an accurate picture of the inflation trend.

Narrow Money

If broad money growth gives us the general direction of travel then narrow money gives us the impulse for the next few months or so. How is that going?

The annual growth rate of the narrower aggregate M1, which comprises currency in circulation and overnight deposits, decreased to 6.4% in August from 6.9% in July.

This compares to the 9.9% of September last year which is the recent peak. So the short-term impulse has weakened considerably since then and in terms of quarterly GDP growth we have seen a drop from around 0.7% to 0.4% or so. Of course we are now left wondering if more is to come?

A significant part of this has been the actions of the ECB itself as the 9.9% growth of last September was a consequence of monthly QE purchases being ramped up 80 billion Euros per month in the year from April 2016. Now of course we are in a different situation with them about to drop from 30 billion to 15 billion. This suggests that the fall in M1 growth has further to go.

What about credit?

These have been in a better phase so we can expect the ECB and its area of influence to give them emphasis.

However in my view there are two issues with this. The opening one is that they are  backwards as well as forwards looking as they represent a response to the better growth phase the Euro area was in. The next is that they are in the M3 numbers and in fact represent basically its growth right now ( 3.4%) as the other components net out.

Comment

Today’s news continues a theme of 2018 which is that money supply growth has been fading. In the Euro area this has been exacerbated by the winding down of the expansionary monetary policy of the ECB. Some of it is still there as it used to tell us that a deposit rate of -0.4% was a powerful influence here but much of the QE flow has gone. Thus in the period ahead we will find out if the Euro area economy was like a junkie sipping the sweet syrup of combined QE and NIRP. This morning’s economic sentiment data showing a drop of 0.7 to 110.9 might be another example of people and businesses getting the message.

Looking at the international environment we see that the ECB is increasingly out of phase. Not only did the US Federal Reserve raise interest-rates but so did a central bank nearer to home.

At its meeting today, the CNB Bank Board increased the two-week repo rate (2W repo rate) by 25 basis points to 1.50% ( C = Czech )

The situation is complex as we wait to see if they depress the international economy or we shake it off. But the ECB remains with negative interest-rates when economic growth looks set to slow. What could go wrong?

Me on Core Finance TV

 

 

 

 

The struggles of the French economy are continuing

This morning has brought more disappointing news both for and from the French economy. The statistics institute has released this.

In September 2018, households’ confidence in the economic situation has declined: the synthetic index has lost 2 points and reached its lowest level since April 2016. It remains below its long-term average (100).

This index has been in use for 31 years now so the fact that it is below its long-term average does give us some perspective. Also reaching a level not seen since April 2016 takes us back to around when what we might call the Euroboom began (in the second quarter of 2016 the French economy shrank by 0.2%) which will provide some food for thought for the European Central Bank or ECB. It has been on the wires leaking hints about how it will continue to withdraw its monetary stimulus just as its second largest economy has shown more hints of weakness. If we stay with the Euro theme this measure welcomed it by going above 120 but such heady days were capped by 9/11 and now we have seen 97,97,96 and then 94 in September. So there has been a long-running decline overall which did see a rally in the period 2013 to 17 but perhaps ominously turned down at a similar level to 2007/08. Also the outlook is not bright according to French households.

Future standard of living in France: strong
degradation……… The share of households
considering that the future standard of living in France
will improve in the next twelve months has sharply
declined: the corresponding balance has lost 7 points
and stands below its long-term average.

Markit PMI

This hammered out a similar beat last week.

Output growth across the French private sector
slipped to its lowest since December 2016 during the
latest survey period, with data indicating a broadbased
slowdown across both the manufacturing and
service sectors.

This slowdown had as part of it something you might expect with the ongoing diesel debacle and the trade wars.

Manufacturing businesses frequently reported a deterioration in the automotive sector.

This poses a question if we move to what the French economy did in the first half of 2018. Just as a reminder quarterly economic growth went 0.2% in something of a surprise but then backed it up with another 0.2% reading. I contacted Markit’s chief economist pointing out that a reduction on 0.2% as implied by their survey looked grim. But they are sticking to the view that France did better in the first half of the year and in spite of the recorded slowdown is doing this.

Across the region, growth slowed in Germany and
France but both continued to outperform the rest of
the eurozone as a whole, where the pace of
expansion held close to two-year lows.

I have no idea how France is outperforming by doing worse but there you have it. There were times when Markit was accused by the French government of being too pessimistic about France whereas now it must be delighted with its work.

The official surveys for businesses are also above their long-term averages but the situation here is awkward especially if we look at services. Here the confidence indicator has been stable around 105 for a few months or so suggesting growth and yet if we move to the actual data we know that the French economy has struggled.

Bank of France

In the circumstances the projections released earlier this month look rather optimistic.

In a less dynamic, more uncertain international
environment, French GDP is expected to expand
by 1.6% in 2018, 2019 and 2020. GDP growth
should remain above potential, helping to drive
further reductions in France’s unemployment rate.

They are plainly suggesting that the first half of 2018 will be followed by a vastly more dynamic second half involving growth of 1.2% as opposed to 0.4%. But once you look past that I note that 1.6% economic growth is described as “above potential” which to me seems somewhat depressing. Central bankers have a habit of thinking the same thing at the same time and this reads rather like the 1.5% speed limit that the Bank of England Ivory Tower has suggested for the UK economy.

In essence it is downbeat for domestic demand but hopes that export growth and some investment growth will take up the slack. Let us hope that it is right about the area below as unemployment in France remains elevated compared to its peers.

The ILO unemployment rate should fall gradually
to 8.3% at the end of 2020 (France and overseas
departments)

Although that is still high meaning that for some in France unemployment will be all that they have known.

Public Finances

Perhaps we are seeing an official response to the growth malaise. From Reuters.

France will reduce the tax burden on households and companies by nearly 25 billion euros ($29.4 billion) next year, the government said in its 2019 budget bill, pushing the deficit up towards an EU cap as the economy fails to gain pace.

This represents a change of direction although we do see something very familiar these days in the split between businesses and individuals.

Households will see their tax bill reduced by a total 6 billion euros while business taxes will fall by 18.8 billion euros, resulting in the overall tax burden decreasing to 44.2 percent of national income, the lowest for France since 2012.

There is also some pump priming on the expenditure side of the accounts although it is a reduction on the previous 1.4%.

While the government has kept overall public spending stable this year after inflation, the 2019 budget foresees an increase of 0.6 percent after inflation.

If we move to the debt situation we see what is a factor in President Macron’s enthusiasm for a shared budget in the Euro area.

At the end of Q1 2018, the Maastricht debt reached
€2,255.3 billion, a €36.9 billion increase in comparison
to Q4 2017. It accounted for 97.6% of gross domestic
product (GDP), 0.8 points higher than last quarter’s
level.

This looked like it was going through 100% but was rescued by the growth spurt. Now we wait to see what happens next should the French economy continue the struggles of the first half of 2018.Also there are risks on the debt costs side as we see two factors at play.The first is the tend towards higher bond yields we have sen recently and the second is the ongoing reduction in ECB purchases of French government bonds which had reached 410 billion Euros at the end of August.

Comment

If you want some good news then the sporting front has provided it for France in 2018 with its football world cup victory and it is just about to host golf’s Ryder Cup. But the economic news has disappointed pretty much across the board in an irony considering it is supposed to now have a business friendly government. It is true that the tax cuts are weighted towards the private-sector but so far the economy has slowed down rather than speeding up.

Unless the French statistics office has been missing things the ECB will also be noting that its second largest economy has turned weaker. That will provoke thoughts suggesting it can only boom in response to pretty much flat out monetary stimulus. Also there will be worries about what might happen if the ECB tightens policy as opposed to reducing stimulus. There is a case for that from the inflation data as the annual rate has risen to 2.6% on the equivalent measure to UK CPI which may be why French consumers feel so negative about the economy.

The current issues with the sale of Rafale fighter jets to India seems symbolic too. Corruption in such sales is of course far from unique to France but I also note that the way President Macron is distancing himself from it ( It was not on my watch….) bodes badly for what may happen next.

 

 

 

 

 

What next from the war on cash?

This morning the BBC has posted an article on a subject I was mulling last Wednesday.  As I walked into an appointment for some treatment for my knee the person before me was paying for his appointment by using his phone and transferring the money directly. I by contrast had put some cash in my pocket so I could pay in that fashion. If we move on from me suddenly feeling rather stone age and he being much more cutting edge there was one work related issue on my mind. What does paying by phone do to the money supply? It reminds us that the money supply also includes the ability to borrow and whilst everyone obsesses about banks also reminds us that it can now come from other sources. Or perhaps I should correct that to their being more potential routes these days.

Paying by phone

Here is an example quoted by the BBC.

Nikki Hesford, 32, is a convert to person-to-person payment (P2P) apps, using PayPal to pay for services and Venmo to pay back friends.

“The only time in the last year I’ve drawn out cash is for the school fete cake stall and to pay my manicurist,” says Ms Hesford, who runs her own marketing support company for small businesses.

“If I go for a meal with friends I can’t be bothered messing about with two, three or four cards,” she says.

“One person will pay on a card and the others will transfer through an app. It takes seconds rather than minutes fussing around with who owes what.”

PayPal has been around for some time but the likes of Venmo seems a real change and I can see the attraction. Who has not been out to eat with a group and been in a situation where the money collected in is short but everyone claims to have paid? For all our thoughts that millennials and Generation Z have it tough they may have stolen a bit of a march on the rest of us here. Venmo will by its very nature record each transfer and provide a type of audit trail.

In terms of scale then the position is building.

Zelle, one of the most popular payment apps in the US backed by 150 banks, launched in June 2017, but has already processed more than 320 million transactions valued at $94bn (£72bn).

A recent report by Zion market research suggested that the global mobile-wallet market in general is expected to top $3bn by 2022, up from nearly $600m in 2016.

The argument in favour is that it is quick and convenient,

Rachna Ahlawat, co-founder of Ondot Systems, a payment services platform, perceives a marked change in consumer behaviour.

“We want transactions to happen in an instant and at the click of a button,” she says. “Consumers not only want to operate in real-time, but they are looking for technology that allows them to play a more active role in how they control their payments, and are finding new ways of managing their financial lives.”

Financial Crime

The official and establishment view is that cash is a curse and the high priest of such thoughts Kenneth Rogoff wants this.

Why not just get rid of paper currency?

His opening argument is that cash is a source of crime.

First, making it more difficult to engage in recurrent, large, and anonymous payments would likely have a significant
impact on discouraging tax evasion and crime; even a relatively modest impact could potentially justify getting rid of most paper currency.

Yet we discover that even the new white heat world of person to person payments has you guessed it found that the criminal fraternity are very inventive.

“Malware injections and reverse engineering attacks can be used by hackers to understand the app’s code and silently trick you, going undetected by the typical security measures.”  ( Pedro Fortuna from JScrambler )

The truth is that whatever financial area we move into we take the criminals with us and sometimes there are already there waiting for us to make a mistake.

“With the increasing number of apps all requiring some form of authentication, it’s all too tempting to reuse passwords across multiple services. This increases the risk of your data being hacked.”  ( Sam Devaney from CGI UK ).

The banks

There is a very inconvenient reality for the likes of Kenneth Rogoff which is that so much financial crime is to be found at the heart of the system “the precious”.

Banks in Denmark, the Netherlands, Latvia and Malta have all been linked to criminal inflows from countries including Russia and North Korea. The EU has moved to centralize banking supervision, but money laundering has remained a national responsibility.

At the moment the European Union seems to be the weakest link in this area although of course it is far from unique. As an example the situation at Danske bank was so bad it even found itself being trolled by Deutsche Bank which claimed it was only accepting one in ten of past Danske bank clients. According to the Wall Street Journal around US $150 billion of transactions are being investigated according to Reuters the bank itself is discovering large problems.

the Financial Times cited the bank’s own investigation as saying the Danish bank handled up to $30 billion of Russian and ex-Soviet money through non-resident accounts via its Estonian branch in 2013 alone.

The European Union seems to be particularly in the firing zone in this area right now and much of it seems centred in the Baltic nations. That reminds me that back on the 19th of February I looked at the issues facing ABLV in Latvia which developed into a situation where the central bank Governor Ilmārs Rimšēvičs has been charged with taking a bribe.

Whilst the European Union is presently in the firing line we know that banking scandals of this sort occur regularly in most places. Yet the establishment ignore the way that the banks are the major source of financial crime in their rush to implicate cash.

Some new notes

A sign that there is indeed counterfeiting happen was provided yesterday by the European Central Bank or ECB although it chose to present it another way.

New €100 and €200 banknotes unveiled!

Sadly the excitement captured only a couple of journalists attention but the press release did hint at “trouble,trouble,trouble.”

The new €100 and €200 banknotes make use of new and innovative security features.

I think we know why! But there was another sign.

In addition to the security features that can be seen with the naked eye, euro banknotes also contain machine-readable security features. On the new €100 and €200 banknotes these features have been enhanced, and new ones have been added to enable the notes to be processed and authenticated swiftly.

It makes me wonder how many counterfeit ones are in existence. This seems likely to get Kenneth Rogoff to add those note to the 500 Euro ones he wants banned.

Comment

This is a situation which has a paradox within it. We see that technology is providing plenty of ways which provide alternatives to cash and in spite of presenting myself as something of a cash luddite earlier I find them convenient too. Yet we want more cash in the UK the £40 billion mark was passed in 2008 and now we have according to the Bank of England.

There are over 3.6 billion Bank of England notes in circulation worth about 70 billion pounds.

We are far from alone as for example in 2017 the growth rate was 7% for the US and Canada and 4% for the Euro area and Japan. Yet the Bank of England confirms that the medium of exchange case has indeed weakened over time.

Cash accounted for 40% of all payments in 2016, compared to 62% in 2006

The Bank will have something of an itchy collar as it notes that the increased demand for cash will be as a store of value and the rise accompanies its era of QE and low interest-rates. Kenneth Rogoff is much more transparent though.

Although in principle, phasing out cash and invoking negative interest rates are topics that can be studied separately, in reality the two issues are deeply linked. To be precise, it is virtually impossible to think about drastically phasing out currency without recognizing that it opens a door to unrestricted negative rates that central
banks may someday be tempted to walk through.

As Turkish points out in the film Snatch “Who da thunk it?”

 

 

The Italian economy looks to be heading south again

Today has opened with what is more disappointing economic news for the land of la dolce vita. From the Italian Statistics Office or Istat.

In July 2018 the seasonally adjusted industrial production index decreased by 1.8% compared with the previous month. The percentage change of the average of the last three months with respect to the previous three months was -0.2.
The calendar adjusted industrial production index decreased by 1.3% compared with July 2017 (calendar working days being 22 versus 21 days in July 2017);

As you can see output was down both on the preceding month and on a year ago. This is especially disappointing as the year had started with some decent momentum as shown by the year to date numbers.

 in the period January-July 2018 the percentage change was +2.0 compared with the same period of 2017.

However if we look back we see that the push higher in output came in the last three months of 2017 and this year has seen more monthly declines on a seasonally adjusted basis ( 4) than rises (3). Looking ahead we see that things may even get worse as the Markit PMI business survey for manufacturing tells us this.

Italy’s manufacturing sector eased towards
stagnation during August. Both output and new
orders were lower, undermined by weak domestic
demand, whilst employment increased to the
weakest degree since September 2016……..Expectations were at their lowest for over five years.

This seems set to impact on the wider economic position.

At current levels, the PMI data suggest industry
may well provide a net negative contribution to
wider GDP levels in the third quarter of the year.

With Italy’s ongoing struggle concerning economic growth that is yet another problem to face. But it is something with which it has become increasingly familiar as the industrial production sector is still in a severe depression. What I mean by that is the peak for this series was 133.3 in August of 2007 and the benchmarking at 100 for eight years later (2015) shows what Taylor Swift would call “trouble,trouble,trouble” . The initial fall was sharp and peaked at an annual rate of 26% but there was a recovery however, in that lies the rub. In 2011 Italy saw a bounce back in production to 111.9 at the peak but then the Euro area crisis saw it plunge the depths again. It did respond to the “Euroboom” in 2016 and 17 but looks like it is falling again and an index of 105.2 in July tells its own story.

So all these years later it is still 21% lower than the previous peak. We worry in the UK about a production number which is 6.1% lower but as you can see we at least have some hope of regaining it unlike Italy.

The wider outlook

Italy’s economy is heavily influenced by its Euro area colleagues and they seem to be noting a slow down as well. From @stewhampton

The ECB committee that oversees the compilation of the forecasts now sees the risks to economic growth as tilted to the downside.

Perhaps they have suddenly noted their own money supply data! At which point they are some time behind us.  Also in the language of central bankers this is significant as they do not switch from “broadly balanced” to “tilted to the downside” lightly, and especially not when they are winding down a stimulus program.

So we see that the Italian economy will not be getting much of a boost from its neighbours and colleagues into the end of 2018.

Employment

Yet again this morning’s official release poses a question about the economic situation in July?

In the most recent monthly data (July 2018), net of seasonality, the number of employees showed a slight decrease compared to June 2018 (-0.1%) and the employment rate remained stable.

This modifies the previous picture which had been good.

The year-on-year trend showed a growth of 387 thousand employees (+1.7% in one year), concentrated among temporary employees against the decline of those permanent (+390 thousand and -33 thousand, respectively) and the growth of the self-employed (+30 thousand).

So more people were in work which is very welcome in a country where a high level of unemployment has persisted. We keep being told that the unemployment rate in Italy has fallen below 11% ( in this instance to 10.7%) but then later it gets revised back up again. Of course even 10.7% is high. I would imagine many of you have already spotted that the employment growth is entirely one of temporary jobs which does not augur well if things continue to slow down.

Some better news

Italy is a delightful country so let us note what some might regard as a triumph for the “internal competitivesness” policies of the Euro area.

Italy’s current account position is one of the country’s most improved economic fundamentals since the financial crisis. As the above chart shows, it improved by 6.2 percentage points to a sizable surplus of 2.8% of gross domestic product (GDP) last year—the highest level since 1997—from a deficit of 3.4% of GDP in 2010.

That is from DBRS research who in this section will have the champagne glasses clinking at the European Commission/

external cost competitiveness gains related to relatively slower domestic wage growth.

The Italian worker who has been forced to shoulder this will not be anything like as pleased as we note that some of the gain comes directly from this.

In response to the recession, nominal imports of goods declined significantly by around 5% a year between 2012 and
2013.

Also Italy has benefited from lower oil prices.

Since then, lower energy prices further contributed to the improvement in the current account, and Italy’s imported energy bill bottomed out at 1.6% of GDP in 2016, down from a peak of 3.9% of GDP in 2012.

Not quite the export-led growth of the economics textbooks is it? Still maybe there will be a boost from tourism.

Why everyone is suddenly going to Milan on vacation ( Wall Street Journal)

According to the WSJ Milan has  “been hiding in plain sight for decades ” which must be news to all of those who have been there which include yours truly.

Comment

The downbeat economic news has arrived just as things seemed to have got calmer regarding the new coalition government. Or as DBRS research puts it.

More recently, the leaders have reaffirmed their commitment to adhere to the European Union (EU) framework. In DBRS’s view, this is a positive development.

This has meant that the ten-year bond yield which had risen above 3.2% is now 2.75%. So congratulations to anyone who has been long Italian bonds over the past ten days or so and should you choose you will be able to afford to join the WSJ in Milan as a reward. However bond yields have shifted higher if we return to the bigger picture so this will continue to be a factor.

In DBRS’s view, total interest expenditure as a share of gross domestic product (GDP) may slightly narrow this year compared with the 3.8% of GDP recorded in
2017.

As new issuance has got more expensive than in 2017 I am not sure about the narrowing point.

Also there is the ongoing sage about the Italian banks which has become something of a never-ending story. Officially Unicredit has been the success story here and yet if it is such a success why were rumours like these circulating yesterday?

The other rumour was a merger with Societe Generale of France. Anyway the current share price of around 13 Euros is a long way short of the previous peak of 370 or so. This reminds us of the news stories surrounding the fall of Lehman Bros. a decade ago as it has been a dreadful decade for both Unicredit and Italy as we note the economy is still 5% smaller than the previous peak.