PJ Grzywacz
President, Chief Compliance Officer
CMG
È tempo per un po ’di QE? Nein danke. Vielleicht?
TRANSLATED: Is it time for a little QE? No thank you. Maybe?
Although Mario Draghi, President of the European Central Bank (ECB), announced that the Bank’s governing council is prepared to take emergency action if inflation falls too low, it may be a case of too little, too late. By emergency action, he of course means quantitative easing, which to this point has been anathema to German policy makers.
Each of the EU’s competitors has acted with some form of stimulus, loose monetary policy or unconventional quantitative easing in an attempt to stimulate growth. In the U.S. we have gone through every monetary tool in the bag. In the UK, the Bank of England is so pleased with its QE, it is considering whether it needs to make “any adjustments” (read “any” as in “any, ever”) at all to its bond buying programs.
The Japanese, through Abenomics, have made an all out commitment to fight deflation by doubling the size of the Bank of Japan’s balance sheet, expanding the money supply and depreciating the yen. Japanese equity markets took off last year, but have since come back down to start 2014 as Shinzo Abe prepares to increase the national sales tax from 5% to 8%. Last year, the iShares MSCI Japan ETF (Ticker: EWJ) gained 26.48% but has declined close to 7% in 2014.
The fear is that consumers and businesses have moved spending up ahead of the tax hike and GDP will fall off a cliff (the Japanese have seen this film before in 1997 when they prematurely hiked the sales tax from 3% to 5%). All of these initiatives pale in comparison to the amount of money China has infused into its economy in an attempt to buoy growth.
According to JP Morgan, since 2010, the Chinese shadow banking system has grown from $2.4 to $7.7 trillion. A large portion of the growth has gone into real estate and real estate-related funds and trusts that are now more recently getting squeezed by Xi Jinping’s, China’s president, new economic policies. To further support growth, China has now reversed it currency policy by actively pushing the yuan down. Now enter the EU.
Mario Draghi
President
European Central Bank
It has been the lack of inflation that has Mr. Draghi worried; namely the March reading of 0.5%, the lowest level since the financial crisis in 2009. For an economic zone running at two different speeds, this spells real trouble. The southern block, namely Italy and Spain, face the prospect of outright deflation and an environment where the real value of their sovereign debt doesn’t come down as fast at it would like. Both countries could still face rising debt ratios despite several rounds of austerity and reforms.
Despite the risk of falling into a Japanese style deflation trap, Mr. Draghi and the ECB, declined to cut interest rates from 0.25% to zero, believe that the dip in inflation is seasonal and should move higher in the coming months. Indeed, German industrial output rose for a further consecutive month, suggesting that the German economy, which accounts for nearly a third of EU output, is doing just fine, leading analysts to revise growth up, to just shy of 3% for the year.
This crystallizes the core European problem: a German economy that is doing well setting policy for a block of southern European economies struggling to stay above water. That struggle is neatly wrapped into a one-size-fits-all currency that is now the most expensive in the world, up over 6% in trade weighted terms in the past year.
The hope is that Germany is coming around. Although the German constitutional court in a recent ruling called an ECB bond rescue program a breach of EU treaty law, there is sign that policy makers are softening their stance. The German Institute for Economic Research, one of the leading research and policy institutes in Germany, recently came out in support of a bond buying program (60 billion Euros a month) on the model of the Federal Reserve, designed to stave off deflation.
Despite the tough talk from Mr. Draghi, the concern is that it is too little, too late. Much like the Keynes’s paradox of thrift (or paradox of saving), if all economies try to devalue their currencies or ease policy at the same time, the net effect is muted or diminished altogether. By the time all of Europe comes around, the party may already be over. – PJ Grzywacz
