In this short video we explore risks of a prolongued period of tension between North Korea and the West.
Daniel Lacalle is Chief Economist at Tressis, SV a PhD in Economics and author of Life In The Financial Markets, The Energy World Is Flat (Wiley) and Escape from the Central Bank Trap (BEP).
This article was published at World Economic Forum here.
If there is a term that can best describe the current climate in the Eurozone, it is “complacency”. Markets are rising, bond yields are at an all-time low, growth estimates have improved and the European Union has triumphantly declared the end of the crisis, thanks to its “decisive action”.
There is no denying that the European Union is in recovery mode, and that is a positive. Business confidence is rising, and manufacturing indices are in expansion. However, the pace of said expansion has moderated in the past months, and challenges remain.
The biggest problem for the Eurozone is demographic. The population is ageing rapidly, and in several countries that issue is compounded by a shrinking number of inhabitants. Average age in the largest Eurozone countries ranges between 44 and 47. At the same time, the United Nations estimates that the European Union population will have peaked and start shrinking in less than two decades. Less people and older, too.
Ageing presents many challenges. The cost of healthcare and pensions rise, while tax revenues decrease as consumption and investment slow down. This demographic challenge creates a fiscal and productivity challenge that can only be reversed by attracting high added-value investment and incentivizing high productivity sectors. The European Union is doing the opposite: it mostly subsidizes low productivity and taxes the productive, penalizing foreign technology giants and increases the tax wedge on small and medium enterprises.
This takes us to the second risk. The euro has strengthened against all its main trading currencies, despite a massive expansionary monetary policy that has taken the European Central Bank’s balance sheet to 35% of the Eurozone GDP. Eurozone countries mainly export to each other, with 75% of exports made within the single currency boundaries. This means that financial repression measures might help to artificially boost internal demand through credit expansion, but it immediately creates an inconvenient side-effect by strengthening the euro. As such, non-EU28 export growth has stalled since the European Central Bank started its enormous asset purchase programme.
A strong euro is not a problem for consumers or high-added-value companies. Consumers benefit from low inflation, and their savings are predominantly in deposits, so a strong euro helps families navigate a challenging environment thanks to contained prices and better purchasing power. High-added-value companies are exporting without a problem, as demand for quality and advanced products is soaring, and these companies do not need the artificial subsidy of devaluation to increase sales.
A strong euro is a problem for the European Central Bank’s plan to inflate its way out of debt. Inflation expectations have been cut dramatically in the past month, and this obliterates the idea that price increases will help deflate the debt of deficit-spending countries.
The strong currency is a relevant problem for low-added-value and productivity sectors. The main trading partners of the Eurozone are the US and China, which account for nearly 50% of the group’s exports. A strengthening single currency diminishes the possibilities of selling more abroad, when competitiveness is not driven by technology or innovation, but costs. As the Eurozone has focused its efforts in supporting these weak-to-average competitiveness sectors though low rates, devaluation and subsidies, it is a challenge for them to grow when the euro becomes a “safe haven” currency. Additionally, investors are realizing that a strong euro erases the earnings growth estimates of the large European stock market indices, making stocks more expensive in the process.
The third risk is financial. The Bank for International Settlements warns that the percentage of zombie companies has soared to 9% of the total of large quoted non-financial entities. Zombie companies are those unable to cover financial expenses with operating profits. At the same time, non-performing loans in Eurozone banks have reached a three-year high of more than €1 trillion, 5.1% of total loans.
What these figures tell us is that ultra-low rates and massive liquidity have not made the financial and corporate system stronger, but weaker. European governments have “saved” nearly €1 trillion in financial costs due to the European Central Bank’s extreme loose monetary policy, but the vast majority of them remain in deficit and continue to delay essential reforms to strengthen their fiscal position. In fact, there are political calls all around Europe to spend more and forget the wrongly called austerity, which was in reality just a very moderate budget adjustment.
There is an even more concerning conclusion. Neither deficit-spending countries nor weak companies would be able to absorb a mere 1% increase in rates, and the financial system would suffer more liquidity and solvency episodes than the ones we have seen in the past years.
The European Central Bank cannot fix structural problems, and it seems that countries and companies have forgotten that unconventional monetary policies are there to buy time to strengthen the system and undertake reforms and restructuring, not to grow accustomed to massive liquidity and low rates as a given. Complacency is the last thing that European governments and companies should fall into.
Daniel Lacalle is Chief Economist at Tressis, SV a PhD in Economics and author of Life In The Financial Markets, The Energy World Is Flat (Wiley) and Escape from the Central Bank Trap (BEP).
Article and photo courtesy World Economic Forum. Image courtesy Eurostat. Re-printed with permission.
Yellen and Draghi seemed to say very little at Jackson Hole, but the market made a lot of assumptions.
In this video we explain how post-Jackson Hole, consensus is shifting towards believing in perpetuated loose policies, and the warning signs in oil prices falling in tandem with the US dollar as well as Gold.
Enjoy!
Daniel Lacalle is Chief Economist at Tressis, SV a PhD in Economics and author of Life In The Financial Markets, The Energy World Is Flat (Wiley) and Escape from the Central Bank Trap (BEP).
Article published originally here.
The primary purposes of the incorrectly named “unconventional monetary policies” are to debase the currency, stoke inflation, and make exports more competitive. Printing money aims to solve structural imbalances by making currencies weaker.
In this race to zero in global currency wars, central banks today are “printing” more than $200 billion per month despite that the financial crisis passed a long time ago.
Currency wars are those that no one admits to waging, but everyone wants to fight in secret. The goal is to promote exports at the expense of trading partners.
So how must the bureaucrats at the European Central Bank (ECB) feel when they see the euro rise against the U.S. dollar and all its main trading currencies by more than 12 percent in a year, despite all the talk about more easing? The ECB will keep buying 60 billion euro a month in bonds, maintain its zero interest-rate policy, and keep this “stimulus” as long as it takes, until inflation growth and GDP growth are stable.
Contrary to the wishes of the ECB, however, a strong euro is justified for several reasons. First, the European Union’s trade surplus is at record highs, and 75 percent of Eurozone trade happens between Eurozone countries. Higher exports and the continued recovery of internal demand in European member countries strengthen the euro.
The third is the perception of weakness of the U.S. government and its inability to push through key reforms. This has weakened the dollar and by definition strengthened the other two large trading currencies, the euro and the Japanese yen.The second important factor is the relief rally after the French and Dutch elections. The fears of a Euro breakup have been eliminated, or at least delayed, as pro-EU political parties won.
However, a strong euro has very significant implications for the EU economy and the ECB’s policy.
The strong euro puts exports to its main outside trading partners, the United States (20.8 percent of exports in 2016) and China (9.7 percent), at risk. Despite the ECB’s extreme monetary policy and a euro trading almost at parity with the dollar, exports to non-EU countries have stalled since 2013. GDP growth estimates for 2018 are falling due to a lower contribution of net exports.
The currency also has a high impact on tax revenues in Europe. The correlation between the euro–dollar exchange rate and the earnings estimates of the largest multinationals represented in the Stoxx Europe 600 Index is very high.
According to our estimates, a 10 percent rise of the euro against the dollar is equivalent to an 8 percent drop in earnings and leads to lower corporate tax revenues. From an investment perspective, as earnings drop, the European stock market goes from being relatively cheaper to becoming more expensive.
Investors and economists need to pay attention to these factors. If the euro continues to strengthen, the EU economic recovery is at risk. So the Eurozone is stuck between a rock and a hard place. It cannot stop the stimulus because deficit spending governments cannot live with higher financing costs, and increasing the stimulus to weaken the currency simply doesn’t work anymore.
The only way out is structural reforms, but most governments are afraid of them even in good times, let alone when the going gets tough.
Daniel Lacalle is chief economist at investment management company Tressis and author of the recent book “Escape from the Central Bank Trap” (published by BEP).
Courtesy of The Epoch Times. Read here.