Mario Draghi has again missed an exceptional opportunity to adjust monetary policy. By ignoring the huge risks that are being created from the brutal inflation of financial assets, saying that “there are no signs of a bubble“, the European Central Bank (ECB) remains adamantly foused on creating inflation by decree, denying the effects of technology, demography and overcapacity.
“No signs of bubble”? I’ll show you some of them myself .
– Percentage of debt of major countries “bought” by the ECB: Germany, 17%, France 14%, Italy 12% and Spain 16%. In all cases, in 2016 and 2015 the ECB was the largest buyer of said countries’ net emissions.
Ask yourself a question: On the day the ECB stops buying, which of you would buy peripheral or European bonds at these prices? Clearly, the first sign of a bubble is the absence of demand in the secondary that offsets the impact of the ECB. It indicates that the current price is simply unacceptable in an open market, even if the recovery is confirmed, especially because rates do not even reflect a minimum real return, being below inflation.
– European Union high-yield bonds are trading at record-low yields despite the fact that cash generation and debt repayment capacity, according to Moody’s and Fitch, have not improved significantly
– European largest stocks (Eurostoxx 50) trade at 20x PE and 8.3x EV/EBITDA despite eight years of flat earnings and downgrades, which have only just recently reversed.
– Infrastructure deals’ multiples have increase five-fold in three years to an astonishing average of 16-19x EBITDA.
– Excess liquidity in the euro zone already reaches 1.2 trillion euros. It has multiplied by almost seven since the “stimulus” program was launched.
Anything for Inflation
There is a problem in the huge amount of assets bought by the ECB, whose balance sheet already exceeds 25% of the European Union’s GDP. At the beginning of the repurchase program, it could be argued that risky assets, especially sovereign bonds, could have been cheap or under-valued because of the risk of break-up of the euro and overall negative sentiment. However, that statement cannot be made today, with bond yields at historical lows and debt levels at historical highs. Monetary policy is a perverse incentive to spend more and add more debt .
Of course, what the ECB expects is the arrival of the inflation mantra , that mirage that deficit states yearn for and no consumer has ever wanted.
But the search for inflation by decree meets the pitfall of reality. The positive disinflation that the technological advance generates (read George Selgin) adds to the logical change of consumption patterns due to ageing of the population and the elephant in the room: The European Union has never had a problem of lack of investment, but of excess spending on dozens of industrial and infrastructure plans that have left behind some positive effects, but – due to excess – greater debt and overcapacity .
Now that prices are moderating again with the dilution of the base effect, the opportunity to moderate this unnecessary monetary stimulus is lost. As I explained at CNBC on Monday, the supposed positive effects of the buyback program cannot make us ignore the accumulation of risk in sovereign and corporate bonds and the dangerous impact on the financial sector.
Draghi, at least, warns
The president of the ECB does not stop alerting governments about the importance of reforms to drive growth, lower taxes and reduced imbalances, but no one hears. When Draghi warns banks of their weaknesses, they don’t listen either. When he reminds deficit spending governments that monetary policy has an expiration date, they look the other way. It’s party time .
Monetary policy is “like Coca-Cola,” said Jens Weidmann , president of the Bundesbank. A drink that stimulates, but has too much sugar and no real healing qualities.
The problem of losing this opportunity to moderate monetary policy is that it is highly unlikely that the necessary measures will be taken to correct excesses when they are no longer a debate of economic analyst, but evident to all citizens. Because then, the central bank will be afraid of a financial market correction, after a bubble inflated by its policies.
European governments make a huge mistake thinking that prosperity is going to be generated from debt and not from savings. But they make an even bigger mistake if they think that by perpetuating the imbalances, they will prevent a crisis.
At the press conference, Draghi said that “nobody knows when or where the next crisis will come: the only sure thing is that it will come“.
What Draghi did not explain is that the artificial creation of money without support, well above real economic growth, is always behind those crises. But that is another problem, that will be dealt with by the next president of the Central Bank, who will offer the “new” solution … Yes, you have guessed it: Cut rates and increase liquidity.
Daniel Lacalle has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)
Picture courtesy of Google