Draghi Doesn't See "Bubbles" - Let Me Show You Some

Tyler Durden's picture

Authored by Daniel Lacalle via The Mises Institute,

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 focused 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.

  • The 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 increased 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 historic lows and debt levels at historic 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 technological advances generate adds to the logical change of consumption patterns due to aging 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 May 29, 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.

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Batman11's picture

Ben Bernanke doesn’t see bubbles.

https://cdn.opendemocracy.net/neweconomics/wp-content/uploads/sites/5/2017/04/Screen-Shot-2017-04-21-at-13.52.41.png

Dickhead.


Financial stability has been a mystery in this era of boom/bust capitalism.

2008 – “How did that happen?”

The early 1980s see the beginnings of financial liberalisation and the late 1980s sees the following crises, e.g. US S&L crisis; UK, Japan, Australia, Canada and Scandinavia real estate busts.

More financial deregulation leads to 2008; the Euro-zone crisis; Irish, Greek and Spanish real estate crashes.

2008 is just another real estate bust, leveraged up and transmitted internationally by complex financial instruments. As the global bust hits the Euro-zone, it crumbles.

Australia, Canada and Scandinavia are queuing up for their second real estate bust.

Today’s neoclassical economics was around in the 1920s and it led to the roaring 20s and the Great Depression. The roaring 20s, roared because of debt based consumption and debt based speculation. All the debt built up in the boom led to the debt deflation of the Great Depression.

Neoclassical economics was revamped but it still has its old problems.

https://cdn.opendemocracy.net/neweconomics/wp-content/uploads/sites/5/2017/04/Screen-Shot-2017-04-21-at-13.52.41.png

1929 and 2008 stick out like sore thumbs when you look in the right place.

The build up in the ratio of debt to GDP signals the build up of unproductive lending into the economy leading to a Minsky Moment (1929 and 2008).

Productive lending goes into business and industry.

Unproductive lending goes into real estate and financial speculation and it shows up in the graph above.

The UK:

https://cdn.opendemocracy.net/neweconomics/wp-content/uploads/sites/5/2017/04/Screen-Shot-2017-04-21-at-13.53.09.png

We have a problem, a real estate fuelled economy driven by unproductive lending that naturally leads to financial instability.

Neoclassical economics doesn’t consider private debt in the economy and naturally leads to boom/bust capitalism because of this over-sight. It doesn’t even consider debt and so can’t make the finer distinction between productive and unproductive lending.

If you want financial stability, don’t use neoclassical economics.

Batman11's picture

The problem can only be understood by a thorough understanding of money and debt.

How money is created and destroyed on the balance sheets of private banks.

This is where financial crises come from.     

“…banks make their profits by taking in deposits and lending the funds out at a higher rate of interest” Paul Krugman, 2015.

2008 – “How did that happen”

This is not how banks, money and debt work and make the financial system look much safer than it is to today’s economists.

The understanding of money and debt have been regressing for one hundred years.

Credit creation theory -> fractional reserve theory -> financial intermediation theory

 “The movement from the accurate credit creation theory to the misleading, inconsistent and incorrect fractional reserve theory to today’s dominant, yet wholly implausible and blatantly wrong financial intermediation theory indicates that economists and finance researchers have not progressed, but instead regressed throughout the past century. That was already Schumpeter’s (1954) assessment, and things have since further moved away from the credit creation theory.” 

“A lost century in economics: Three theories of banking and the conclusive evidence” Richard A. Werner

http://www.sciencedirect.com/science/article/pii/S1057521915001477

You need the “credit creation theory” of money to get a grip of financial crises and financial instability and today we don’t have that in the mainstream leading to boom/bust capitalism.

 

2008

Today – The bank has lots of valuable mortgage backed securities on its books

Tomorrow – The bank has lots of worthless toxic waste on its books

When these assets are bought with debt you get wholesale money destruction.

This is where financial crises come from.

GreatUncle's picture

The lost century in economics ... reality was the manipulation of those in power of facts to keep the current economic system going as it ever was because it was so good for them.

The only economic principle in 2008 and it does incorporate the former was to allow those in control to position themselves away from the inevitable collapse. Takes time to roll up contracts etc. and around 10 years is all that is needed for the longer term contracts.

If you do not have the inevitable collapse then the power of money ---->>> zero and their money of power ---->>> zero too. Socially equatable.

Time is getting close now ... hence those that are going to be saved are now safely positioned and not so in 2008, so now is the time to tighten the economy, preserve the concept of fiat, with it their value and power. That is the underlying plan of theirs ... it never changed over the years.

Their economic outline for the economy has no consideration of the technological effects and efficiency on a population, it serve only to preserve their precious selves.

I think I get it now central banker ...

The question is do the population truly realise why what is coming will be ... be for thier power and wealth to be preserved  ... where the no importance of a population comes into it? Nope ... they do not have a clue.

Batman11's picture

Neoclassical economics is their grand creation.

The early Classical Economists soon started to cause problems for those at the top by noting the mechanisms by which they were maintained in luxury and leisure and how they were essentially parasites on the economic system.

In the 18th and 19th centuries they were aware there were two sides to capitalism, the productive side where “earned” income is generated and the unproductive, parasitic, rentier side where “unearned” income is generated.

They knew the unproductive side worked against the productive side and believed all taxes should fall on “unearned” income.  

Neoclassical economics corrupted Classical Economics at the end of the 19th and beginning of the 20th Century. 

The distinction between “earned” and “unearned” income disappears at this point and the once separate areas of “capital” and “land” are conflated.

The landowners, landlords and usurers are now just productive members of society and not parasites riding on the back of other people’s hard work, but they are.

BUT ......

This leads to parasitical rentier economies, now spotted by one of today’s Nobel Prize winning economists  “Income inequality is not killing capitalism in the United States, but rent-seekers like the banking and the health-care sectors just might” Angus Deaton.

A floored model of global, free trade that doesn’t consider the minimum wage is set by the cost of living. Western labour is priced out of global labour markets by the high cost of living in the West exacerbated by rentier behaviour.

Known and lost one hundred years ago (deliberately as those at the top are parasites)

It probably helps being in the UK with an aristocracy who haven't done anything for centuries, they are clearly visible.

When it was obvious:

Adam Smith:

“The labour and time of the poor is in civilised countries sacrificed to the maintaining of the rich in ease and luxury. The Landlord is maintained in idleness and luxury by the labour of his tenants. The moneyed man is supported by his extractions from the industrious merchant and the needy who are obliged to support him in ease by a return for the use of his money. But every savage has the full fruits of his own labours; there are no landlords, no usurers and no tax gatherers.”


 

playit's picture

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thisandthat's picture

The rules of the BUBBLE CLUB:

 

1st RULE: You do not talk about BUBBLE CLUB.

2nd RULE: You DO NOT talk about BUBBLE CLUB.

3rd RULE: If someone says "pop" or goes limp, taps out, the bubble is over.

4th RULE: Only two guys to a bubble.

5th RULE: One bubble at a time.

6th RULE: No shirts, no hair.

7th RULE: Bubbles will go on as long as they have to.

8th RULE: If this is your first night at BUBBLE CLUB, you HAVE to bubble.

xtremers9's picture

I don't know about Europe, but let's just focus on the u.s. Yes, valuations are higher than the 100 year average. But valuations have been elevated over the entire past 20 years!

And tech valuations aren't anywhere near as high as 1999/2000

http://bearmarket.net/stock-market-on-june-26-2017-thoughts-and-outlook/

Batman11's picture

It's the debt that's been used to inflate the asset prices that is the problem.

AS interest rates rise it all goes bang.

 

GreatUncle's picture

If anything that is all the CB's have been doing using QE since 2008.

UnschooledAustrianEconomist's picture

"I don't know about Europe, but let's just focus on the u.s."

1:1 same shit on both sides of the big pond.

halcyon's picture

Morons and opporunistic bankers and politicians (Draghi is both!) always claim you can't see bubbles coming, you can only see them with hindsight.

This is wrong.

Bubbles can be spotted in real-time as they are forming. Didier Sornette from ETH Zührich has proven this and is tracking them in real time for more than 3 years now:

http://www.er.ethz.ch/financial-crisis-observatory.html

So next time politicians use this 'no bubbles' or 'we didn't see this coming' crap, call them out on their BS.

 

Batman11's picture

Central Bankers use what is not known to create crises, e.g. Japan 1989, Asian crisis.

The BoJ blew a bubble and burst it just to provide a crisis for the neo-liberal conversion (1989). 

Richard Werner has followed Japan from success to economic basket case, loaded up with government debt in “Princes of the Yen”. 

https://www.youtube.com/watch?v=p5Ac7ap_MAY

This also covers the transition of the other very successful Asian economies to the less successful neo-liberal model, via The Asian Crisis 1997.

Also covers the Euro-zone crisis.

They doth pretend they don't know to wield their power.

“Let me issue and control a nation’s money and I care not who writes the laws.” Mayer Amschel Rothschild (1744-1812), founder of the House of Rothschild.

 

TheSilentMajority's picture

Imagine the corruption, payola, favors, payoffs, commissions, inneficiencies etc that are part of the ECB bond buying program.

Corrupt millionaires and billionaires created daily thanks to the ECB.

moonmac's picture

Politicians are too busy trying to run every aspect of our lives to worry about stupid bubbles.

buzzsaw99's picture

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."

correction:  the only sure thing is how it will be handled.

GreatUncle's picture

Just how they want it ... not so sure the population does ... during one CB recession so long ago now my parents "over money" ended up being divorced.

The preservation of all those who should be saved class, the class none of us are in.

Ink Pusher's picture

It's tough to vizualize the bubble when you are standing inside the bubble pumping it up with your own hot air !

Dragon HAwk's picture

We need a better word than bubble to describe nuclear fission about to go Critical, Bubble is too friendly a word.

lotsofbubbles's picture

Bubbles expand, bubbles burst this is what economics has become, not sure the little people are going to stand for this sort of carry on for much longer