Tag Archives: ecb

Kick the Can Further. Draghi’s Dangerous Bet



Why be shy when you can kick the can and shout ” Sean O’Hagan

When Mario Draghi, the president of the European Central Bank (ECB), analyzed the eurozone’s macroeconomic and monetary data on Thursday, he confirmed a very fragile environment and disappointing figures. However, the stock markets reacted on the upside. Why?

The results

The European economy will grow by 1.7% in 2016 and 2017 and 1.6% in 2018 and 2019. Despite flooding the system with liquidity, expectations have not increased. And, in fact, the risks remains “on the down side” according to Draghi himself.

In terms of monetary aggregates, the increase in M3 fell to 4.4% annualized compared to a growth of 5.5% in September. Loans to the non-financial sectors grew a meager 2%. Remember that all this is happening with the greatest monetary stimulus seen in the history of the euro.

What about inflation? It increased from 0.4% in September to 0.6%. But it is fundamentally because of the cost of energy. Draghi himself recalled that “there are no convincing signs of recovery of underlying inflation” – that which excludes energy and food-.

The velocity of money (nominal GDP / M2) – which measures economic activity – is at multi-year lows and more liquidity and low rates does not help improve it. QE is disinflationary for prices because it sinks interest margins of banks by artificially lowering bond yields and makes economic agents behave with more caution – not rush to spend or to borrow – due to the perception that the cost and quantity of money is artificial. But it is very inflationary in financial assets.

What these figures tell us is that growth is still very poor and the huge amount of monetary stimulus created from the Central Bank does not have the effect that its defenders promised. The European Central Bank’s balance sheet has soared to 3.58 trillion euros, more than 400 billion euros above its 2012 high, and the accumulation of risks is more than evident, even if many decide to ignore them.

The risks

Since the repurchase program was launched in 2015, the excess liquidity accumulated in the system has soared to more than one trillion euros.

The euro-zone has more than 4.2 trillion euros in bonds with zero or negative rates, according to Bloomberg.

The ‘inflation’ that we are told does not exist, lies in the huge bubble of bonds and ultra-low bond yields. This accumulation of risk is exactly as dangerous as that of 2006-2008 but potentially more difficult to contain, since economic agents are not in a better position of solvency and repayment capacity today than in that period, particularly governments, which are much more indebted. This leads to ineficient and heavily indebted governments falling into the trap of thinking that cheap money will always exist and decide to increase their imbalances, entering into a debt shock when rates rise.

If EU countires get used to ultra-low rates the risk of multibillion nominal and real losses in bond portfolios and pension funds is enormous, because the tiniest tilt in inflation will make the house of cards collapse. Goldman estimates losses of $2.5 trillion worldwide from a 1% rise in inflation. It is so relevant that if interest rates raised a stunted 1% in the EU it would lead to massive budget cuts to maintain current deficits.

Of course, Draghi does not stop repeating, and he did it again on Thursday, that this period of excessive liquidity must serve to correct imbalances and implement structural reforms. But no one seems to listen. Cheap money calls for cheap action. More “fiscal stimulus” and more spending.

Draghi, knowing that almost no eurozone economy could absorb the rate hikes and increased risk if the repurchase program ended in March 2017, as it was announced, decided on Thursday to extend it until December although “reducing” the pace of purchases. That is, kick the can forward and an optical reduction because tapering from 80 to 60 billion per month is irrelevant when excess liquidity in the system has soared from about $ 125 billion to $ 1 trillion in the QE program period.

With this measure, Draghi seeks to achieve two things: That governments reconsider their positions and put structural measures in place without creating a serious liquidity problem. On the other hand, to help the yield curve reflect a slight rise that helps banks out of the hole  in which they are with negative interest rates.

The problem is that the structural challenges of the European economy -demography and overcapacity- are not solved by perpetuating imbalances because governments and economic agents simply get used to seemingly temporary measures as if they were eternal.

The perception of excess savings is incorrect in heavily indebted and overcapacity-ridden economies. There is talk of excess savings with respect to investment because the 2001-2007 period of excess spending and debt bubble is used as “normal”. And the central bank floods the market with liquidity thinking that investment will increase if rates fall. As if such drop in rates was “demanded” by the market. But investment is still stagnant with zero rates. Because there is no demand for solvent credit and there is spare capacity after years and years of industrial plans and excesses.

Risk assets jumped on the evidence that such excess liquidity will continue to inflate the bond bubble and hopefully support other financial assets. And in December 2017, if the monetary laughing gas ends, governments will blame Draghi, or Merkel, and not the inaction of a European Union happy to continue with interventionist and anti-growth policies.

And no, most European states are not prepared for the end of QE. They are geared to its extension.

Daniel Lacalle has a PhD in Economics and is author of “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)

This article was originally published in Spanish by @elespanol

Greece Votes ‘No’. Risk On The Rise

“Born to raise hell, we know how to do it and we do it real well”-Motorhead

The referendum in Greece ended with a win of the “no” against the proposals of the European Union.

But this is not the end. It’s the beginning.

For once, Greece’s prime minister Tsipras’ belief that this result will provide the country with more strength to negotiate was and is incorrect. If anything, the result brings the country one step closer to full intervention. Why?

As time passes, Greece is suffering not only from lack of funds to pay for public services and pensions, but its main industry, tourism, is also suffering, with a loss of more than 50,000 visitors in a week.

Greek banks are already requesting further liquidity from the ECB. It is not clear that support will remain indefinitely.

Greece is also facing bankrupcies in the private sector, where most companies are small shops and SMEs suffering from complete lack of credit.

Yes, as we explained last week in our call, this has been a political move, not one looking for the best financial deal.

Syriza has turned a problem of financing and liquidity into one of a possible failed state close to being intervened. While the Greek TV clings on to the “greater fool” theory of a possible Russian or Chinese aid, this has failed to materialize. Not only China and Russia face their own internal issues, but they are unlikely to come to the rescue of a country that sets lack of commitment to creditors at its core.

So, what now?

Don’t expect a quick solution. The EU is unlikely to bow down ahead of a large maturity in August.

Additionally, Greece’s vote is likely to cause shockwaves throughout Europe as we mentioned in last week’s call, with fringe parties making this vote a validation of their own aspirations.

More importantly, so far we have only seen the reaction of the ones that receive… Let’s wait for the answer of the ones that pay. The UK vote is coming soon, and it is unlikely that German, Finnish or Dutch citizens will feel happy to see their taxes raised to maintain Greece’s public spending and generous pensions.

Greece’s demands are simply impossible to grant. And what is most important is that, no matter what happens on a political level, investment and job creation will suffer after the country puts the word “uninvestable” at the door. Greeks are facing a prolongued period of recession and the very likely implementation of much harsher cuts than what they have voted against as the country moves to default and institutional implosion.

For investors there is a very relevant fact to remember. The monetary bazooka of the ECB cannot contain the perception of risk throughout other countries if the EU allows the victory of the message that default and lack of commitment is feasible. This is why the IMF and EU’s response has to be one of strength, or face slow implosion.
Low growth, lack of investment and poor job creation remain the central scenario. In the next months we have to add financial stability and the euro as a sustainable currency to the picture…again.

The referendum is not the end of the Greek drama. It is the beginning of the real drama.


-Daniel Lacalle

About the Author

Daniel Lacalle is an economist and fund manager, and author of ‘Life In The Financial Markets’ and ‘The Energy World Is Flat’ (Wiley).

The Greek Drama

Contributor View written by Daniel Lacalle. Mr. Lacalle is an economist, fund manager and author of Life In The Financial Markets (Wiley) and The Energy World Is Flat (Wiley). You can follow him on Twitter at @dlacalle.

“You can check out any time you like but you can never leave.” -Hotel California

The Greek drama continues to unfold and puts pressure on European markets despite the fact that Draghi´s “monetary laughing gas” continues to pump €60bn per month into the slowly recovering European economy.

The call by the ruling party, the communist Syriza, for a referéndum in Greece, is the last episode of a soap opera that´s starting to be sadly comical.

For once, Syriza is calling a referéndum on State fiscal policy, something that the Greek constitution specifically forbids. It is simply a measure to try to make citizens forget the atrocious negotiating tactics of their government, who could have reached a benefitial agreement much earlier without putting the country on the verge of a bank run.

Additionally, the government is trying to show to the citizens that the Troika proposals are unacceptable when the difference between the document presented by Syriza and the EU´s suggestions are minimal (0.5% of GDP).

The real drama is that none of the measures announced will solve Greece´s real issues. No, it´s not the euro, or the austerity plans. It´s not the cost or maturity of debt. Greece pays less than 2.6% of GDP in interest and has 16.5 years of average maturity in its bonds. In fact, Greece already enjoys much better debt terms than any sovereign re-structuring seen in recent history.

Greece´s problem is not one of solidarity either. Greece has received the equivalent of 214% of its GDP in aid from the Eurozone, ten times more, relative to gross domestic product, than Germany after the Second World War.

Greece´s challenge is and has always been one of competitiveness and bureaucratic impediments to create businesses and jobs.

Greece ranks number 81 in the Global Competitiveness Index, compared to Spain (35), Portugal (36) or Italy (49). In fact it has the levels of competitiveness of Algeria or Iran, not of an OECD country. On top of that, Greece has one of the worst fiscal systems and limits job creation with a combination of agressive taxation on SMEs and high bureaucracy. Greece ranks among the poorest countries of the OECD in ease of doing business (Doing Business, World Bank) at number 61, well below Spain, Italy or Portugal.

Greece´s average annual déficit in the decade before it entered the euro was already 6%, and in the period it still grew significantly below the average of the EU countries and peripheral Europe.

Between 1976 and 2012 the number of civil servants multiplied by three while the private sector workforce grew just 25%. This, added to more than 70 loss-making public companies and a government spend to GDP figure that stands at 59%, and has averaged 49% since 2004, is the real Greek drama, and one that will not be solved easily.

One thing is sure, the Greek crisis will not finish by raising VAT – impacting consumption – and increasing taxes to businesses, nor making small adjustments to a pension system that remains outdated and miles away from those of other European countries. A new 12% “one-off” tax on companies generating profits of more than 500,000 euro will not help job creation and will likely incentivise more tax fraud.

The inefficacy of subsequent Greek governments and Troika proposals is that they never tackle competitiveness and help job creation, they simply dig the hole deeper raising taxes and allowing wasteful spend to go on.

From a market perspective the risk is undeniably contained, but not inexistent. Less than 15% of Greek debt is in the hands of private investors. Most of the country´s debt is in the IMF, ECB and EU countries’ hands. The most impacted by a Greek default would be Germany, which holds bonds of the hellenic republic equivalent to 2.4% of its GDP, and Spain, at 2.8% of GDP, small in relative terms.

Additionally, the ECB prints “one Greece” every three months.

However, the main risk for the Eurozone comes from a prolongued period of no-solutions. Not a Grexit but a “Gredrag,” dragging on for months with half baked attempts to sort the liquidity crisis.

This prolongued agony is unlikely to help investors´confidence. And it might raise questions of the possibility of similar illogical behavior from other fringe parties close to Syriza´s views in the Eurozone, particularly in Spain and France. Because behind this all what lies is an ideological agenda, not the best financial deal for the country. Syriza could be looking to do something similar to what Nestor Kirchner did in Argentina in 2005, cut ties with the IMF and agree to alternative financing with Venezuela at double the cost just for ideological reasons.

Greece exiting the euro remains a distant possibility, despite the headlines. The much publicised “Russian solution” forgets that Russia is not stupid and doesn´t lend at better terms or with easier conditions – think of Syria and Ukraine.

A Grexit would not solve Greece´s challenges, as the country spent decades unsuccesfully trying to solve structural imbalances before joining the euro with competitive devaluations and failed keynesian bets on public spending.

Greece doesn´t need to be a failed state. But governments seem to be inclined to prefer a bank-run and capital controls than to reduce unnecessary spending. The fact that Syriza´s first measure was to re-open the public TV network – undoubtedly a “priority” in a debt crisis- shows how little they care about the “social urgency”.

Greece should stay in the euro, open its economy to business, attract capital, privatize inefficient public sectors, incentivize high productivity sectors with tax deductions, and reduce wasteful spend, not feed the government machine with ever rising taxes to get a few crumbles left by the survivors of the disaster.

If not, in three years time we will be talking of the “Greek crisis” again.