Submitted by David Stockman via Contra Corner blog,
Taken at face value yesterday’s action by the ECB amounted to a monetary farce. How could any adult believe that a benchmark rate cut of 10 bps from an already microscopic level of 25 bps would move the needle in an economic zone that is already groaning under of the weight of $60 trillion in public and private credit market debt?
Similarly, what exactly is the point of negative rates on excess bank funds deposited at the ECB when there will never be any takers? After all, Euro banks do have alternative parking lots for idle cash. Likewise, how does inventing a grand new acronym called TLTRO hide the fact that its essentially a free toaster program for clever loan book managers? As instructed by this swell new ECB writ, they will presently shuffle some funds out of mortgages, sovereign debt or other speculative purposes yet to be defined and into approved “productive” loans. And then they will pass “go”, collect some cheap TLTRO funding from the ECB and collect their own performance bonus for all the bother.
All of this silly kidstuff, in fact, is the work of Keynesian desperados in Frankfurt who embrace two propositions that are unequivocally and provably wrong. Namely, that the Euro area economy is floundering due to a tiny decline in non-financial credit and that “low-flation” is the great roadblock that prevents the wheels of credit and commerce from turning at a more satisfactory pace.
In truth, the Euro zone has had an explosion of bank credit growth to the private non-financial sector. As shown below, outstanding bank loans grew at a 7.5% CAGR during the 10-years ending at the eve of the financial crisis in early 2008. During those halcyon days there was obviously nothing wrong with the bank credit machinery—especially given the fact the euro zone money GDP grew during the same decade at only a 4.4% CAGR. Expressed in absolute dollar terms, the gain borders on a borrowing frenzy. During that decade, non-financial debt outstanding in the euro zone grew by the equivalent of $7 trillion—which is to say, by an amount equal to the entire loan book of the US banking system on the eve of the crisis.
So what happened is nothing more than the universal DM pattern. Borrower balance sheets were dramatically leveraged-up—with non-financial credit rising from 77% of GDP in 1998 to 104% a decade later. But what happened next also conforms to the pattern That is, the euro area household and business sector hit peak debt ratios in the fantastic run up to the financial crisis, meaning that since then leverage ratios have not budged.
Thus, during the next four years ending in early 2012–a few months before the “whatever it takes” moment at midyear— non-financial credit in the euro zone grew at less than 1% annually, and the leverage ratio remained shackled at about 105% of GDP. Moreover, this 90% slowdown in the credit growth rate had nothing to do with the current canard about too little inflation. In the decade before the financial crisis, the euro area CPI rose at a 2.1% annually rate, and during the four post-crisis years at a 1.8% annual rate.
Surely it was not a 30 bp abatement of the consumer inflation rate that brought lending growth to an abrupt halt. Self-evidently, it was the fact that business and household balance sheets in the euro zone had been used up. That was especially true in the periphery countries where the pre-crisis borrowing party had been downright reckless. In short, the problem was peak debt, not low-flation.
The evidence since early 2012 puts the nail in the coffin. During that 27 month period the CPI rose from an index value of 113.5 to 118.3—which is to say, at a 2.0% annualized rate—notwithstanding all the kvetching about an inflation run rate of less than 1% during the last few months. At the same time, non-financial debt outstanding has dropped by about 3%—even as it remains at a near peak leverage ratio of 102% of euro area GDP.
In the Keynesian world where everything is a flow, and balance sheet conditions do not matter, policy-makers are apt to keep hammering the nail of interest rates when debt growth slows or turns marginally negative. In so doing, they are also apt to grab onto any transient condition that provides a fig leaf of justification for their feverish efforts to conjure more of the debt elixir.
But they should riddle us this. If balance sheets don’t matter and low-flation is such a roadblock, why did non-financial debt grow at a 7.5% annual rate under conditions of 2.1% CPI inflation during 1998-2008, but shrink by 3% during 2012-2014 when the CPI has advanced at a 2.0% rate? The obvious answer is that less than fully encumbered balance sheets can only be exploited once, but that the debt party was over and done six years ago.
Indeed, at slightly under 10 trillion euro, non-financial debt outstanding is nearly identical to its early 2008 level. Since then, however, the hang-over from Europe’s single currency debt party has left a deep imprint on the macro-tends, but the clueless Keynesian apparatchiks that dominate policy in Brussels and Frankfurt cannot see it staring them right in the face.
The reality is that money GDP has stopped growing in the euro zone because the cumulative burden of debt and taxes has shut-down the engines of capitalist growth. Thus, between Q1 2008 and Q1 2014, nominal GDP grew at only a 0.7% annual rate—-a mere one-seventh of its credit fueled 4.4% growth rate during the decade long run-up to the financial crisis.
At the same time, the idea that Europe has too little CPI inflation is self-evidently absurd, as should be evident from the graph below. As they say, the CPI index line rises from the lower left to the upper right, and it has rarely missed a beat for two decades running. Accordingly, since early 2008 the euro area CPI has rising at a 1.9% CAGR. That’s as close to the ECB’s ostensible target of “just below 2.0%” as it is possible to imagine.
But it is also a reminder of the true European problem. Real GDP is still below the pre-crisis level because on a trend basis inflation is rising faster than nominal GDP. Consequently, by attempting to stimulate more inflation, Draghi and his band of monetary geniuses would actually widen the inflation/nominal GDP gap, and thereby compound the underlying real growth problem!
The entire proposition that more inflation will lead to more borrowing is just flat wrong under conditions of peak debt. Draghi and company are mindlessly pushing on a Keynesian debt string.
Ironically, the only reason the euro area is suffering a momentary lapse in its 2% inflation trend is that the world’s financial gamblers called Draghi’s “anything it takes” bluff in mid-2012. It should be evident by now that the global financial system has become a moveable momentum feast during our present benighted era of monetary central planning, brutal financial repression and wealth effects ratcheting of risk asset prices by central bank policy.
Accordingly, the gambling heard scooped up the deeply discounted sovereign debt of the periphery and never looked back. Buying begat buying among the gamblers; and rising debt prices caused national banks to load up on their own sovereign issues, too—-thereby accelerating the momentum.
Needless to say, the inflow of gambling money into the euro momo trades that took Spanish and Italian debt from yields in excess of 7% to yields of less than 3% with no change in the underlying macro and fiscal fundamentals, or that “re-opened” the Greek debt market below 5%, also caused a sudden, sharp and persistent rise in the euro exchange rate—-pushing it up by 10% as the so-called Draghi miracle unfolded. So in rounding up the gamblers, Draghi also imported a wagon-load of short-run deflationary pressure.
The euro zone economy has been dead in the water since the 2008 financial crisis. The underlying ailments have been building for 50 years with the rise of the high-tax, high dependency welfare state and the casino capitalism of modern central banking.
Now Draghi & Co have embarked on the futile task of forcing more debt onto balance sheets that are saturated and more inflation into an economy that is shrinking in real terms. But the only thing they can possibly succeed in doing is creating another run on the euro—a run which would cause the global gamblers to take flight and the price of sovereign debt throughout the euro periphery to collapse as fast as it rose.
In the end, however, perhaps the Keynesians in Frankfurt will do something useful. That is, elicit another crisis that will finally put the euro out of its misery.