Is There Any Way Out Of The ECB's Trap?

Tyler Durden's picture

Authored by Daniel Lacalle via The Mises Institute,

The ECB faces the Devil’s Alternative that Frederick Forsyth mentioned in one of his books. All options are potentially risky. Mario Draghi knows that maintaining the so-called stimuli involves more risks than benefits, but also knows that eliminating them could make the eurozone deck of cards collapse.

Despite the massive injection of liquidity, he knows that he can not disguise political risks such as the secessionist coup in Catalonia. The Ibex reflects this, making it clear that the European Central Bank does not print prosperity, it only puts a floor to valuations.

The ECB wants a weak euro. But it is a game of juggling to pretend a weak euro and at the same time a strong economy. The European Union countries export mostly to themselves. Member countries sell more than two-thirds of their goods and services to other countries in the eurozone. Therefore, the more they export and their economies recover, the stronger the euro, and with it, the risk of losing competitiveness. The ECB has tried to break the euro strength with dovish messages, but it has not worked until political risk reappeared. With the German elections and the prospect of a weak coalition, the results of the Austrian elections and the situation in Spain, market operators have realized – at last – that the mirage of “this time is different “in the European Union was simply that, a mirage.

A weak euro has not helped the EU to export more abroad. Non-EU exports from the member countries have been stagnant since the monetary stimulus program was launched, even though the euro is much weaker than its basket of currencies compared to when the stimulus program began. The Central Bank Trap, which I explain in my new book. This shows that export growth is not achieved by artificial subsidies such as a devaluation, but from added value, something that the European Union has stopped looking for.

Escape From The Central Bank Trap explains that the ECB has got itself in a problem that is not easy to solve. The first evidence is that it should have finished its stimuli months ago according to its own plan, but is unable to do it. The second is that, with more than a trillion euros of excessive liquidity, the ECB keeps a figure of repurchases that were clearly unnecessary and that have resulted in the figure of excess liquidity being multiplied by more than ten. The third is that perverse incentives have taken over the European economic policy.

Risks are relevant. This week I had the opportunity to speak at the Federal Reserve Bank of Houston and I explained that the ECB repurchase program exceeds net sovereign bond issuances in the eurozone by more than seven times. Throughout the US QE (quantitative expansion) of the Federal Reserve, it never reached 100% of net issuances. Now that the ECB “reduces” these repurchases to 30 billion euros per month, it will continue to be more than 100% of net issuances.

What does that mean? That the US always maintained a healthy secondary market alive, which guaranteed that there would not be huge risks of collapse when tapering started, because the Federal Reserve bought less than what was issued, paying attention to the market accepting the valuations of bonds and financial assets. By extending the repurchase program, the ECB admits that it does not know if there is a secondary market that would buy European government bonds at current yields.

Ask yourself a question. Would you buy bonds from a heavily indebted state that has stopped its reform impulse with a 10-year yield of less than 2%, if the ECB did not buy them back? Exactly. No.

With more than 8 trillion dollars of bonds with negative yields, the risk of a bubble is huge, because it would lead to large nominal and real losses in thousands of pension plans that only invest in low risk fixed income assets. The interest expense savings that many states boast of, has been largely at the expense of pensioners and savers. The ECB has fallen into its own trap because now it cannot be rigorous with the limit that it established in the absence of a healthy secondary market at these prices.

Pending Financial Reform

The Central Bank Trap is also in a Europe that now demands that banks delay and decelerate the clean-up of their balance sheets. European banks accumulate more than a trillion euros of non-performing loans, and the ECB suffers pressure from many states that have not carried out a financial reform like the Spanish one. These states demand a “softened” restructuring of toxic assets. It’s amazing, but we have not learned anything.

Additionally, zero-bound rates are zombifying the economy.

Ask yourself another question. What type of investments and businesses are incentivized with zero interest rates that were not viable at 1.5%? The Trap does not let Draghi raise rates, something that is urgent when the ECB is almost 200 basis points behind the curve because the economy will suffer. What kind of economy is so weak that it cannot stand a rise of 0.5%? An economy where zombie companies soar – those that cannot pay their interest expense with operating profits despite low rates. According to the BIS, the number of zombie companies has shot up in the last two years to 9% of the large companies. Imagine the small ones.

The trap of the so-called stimulus plan is what it has always been. Once the period and quantity announced have been covered, the ECB itself is hostage to the perverse incentives it created. We are told that there is no bubble, but the ECB cannot stop its repurchases for fear of a collapse in financial markets. Is it not funny? We are told that fundamentals justify financial and political complacency, but if you mention a 0.5% increase in rates, governments and companies faint. If there is no bubble, it is the ideal time to stop something that no longer fulfills its function of mitigating panic. What we see today in the valuations of sovereign bonds is not normalization of excessive yields, but euphoria generated by a single operator. The ECB. And that always brings negative consequences.

The financial system can not heal if rates are kept at ridiculous levels, as much of the banking industry has warned. Additionally, the ECB’s obsession with inflation leads it to ignore the three reasons why prices do not rise as they would like. The accumulated overcapacity after years of demand and subsidy policies, of 20%. Disinflation from technology and efficiency, which is very positive and democratizes the use of goods and services for all income segments. And third, the aging of the European population, which leads to changes in consumption patterns, in addition to higher taxes on the middle class and families, due to the increase in spending on pensions. Those pension systems also suffer from low rates, because the income from social security payments is invested in government bonds with negative real returns. That is, savings are eroded.

Nobody can say that Draghi has not alerted again and again of the needs of reform. But the mistake of the ECB is that they looked to the US and thought they could imitate the Federal Reserve without risk. In the process, they forgot about reforms, about politicians who only want more debt, and to pay attention to the real demand from the markets. Today, despite the urgency, Draghi cannot get out of his trap.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Five Star's picture

The problem is the Euro itself. Since adpotig the Euro southern Europe has seen nearly the worst economic growth in the entire world.

http://thesoundingline.com/ranking-worlds-economic-growth-21st-century-g...

YUNOSELL's picture

I have a novel solution for the ECB -- Why don't they publicly state that they are tightening monetary policy, but behind the curtains they are still pumping in stimulus. Seems to be working for the USSA (for the time being, LOL)

Ghordius's picture

If I get the author right, he says:

- a strong EUR does not hurt exports. it's fine, really

- the ECB is trying to keep it weak, but can't do it forever

and the conclusion is: "It's A Trap!"

charlewar's picture

the author is hyping his book; you buying?

philipat's picture

Actually, no. What the author said was that a weak Euro did not help exports, which have been stagnant. There is a rather important difference there. The article in totality and in context makes perfect sense to any impartial reader (Hmmm) and portends financial problems ahead in the Eurozone. 

PoliticiansDontThinkLongTerm's picture

Do not worry. According to the author it's a deck of cards which is quite stable actually. If it were a house...

billpayer's picture

Weak comment Gordi. What the "independent" ECB really wants is eurobonds, camouflaging the south's unsellable bonds with the north's. In other words: despite most independence movements in Europe being about money, the EU wants to materialize a scenario in which some richer member states pay for the weaker ones without there being any link between them that would suggest more solidarity than let's say in the case of Spain-Catalonia.

 

We should consider ourselves lucky that the EU stands for peace and prosperity. Not. 

JRobby's picture

Thank you!!!

Had to wade through arguments about the Euro to get to your comment.

No discussion of the unemployment problem in Europe? In the USA?

CBs are trapped. 

farmboy's picture

Never yell "fire" in a cinema. It will be busy at the exit.

AlbertthePudding's picture

Shut down rhe ECB ought to do it! It would reduce the level of pedophilia in the world for starters.

AlbertthePudding's picture

Shut down rhe ECB ought to do it! It would reduce the level of pedophilia in the world for starters.

CHX13's picture

Is the Fed trapped (20+ T debt + 100+ T unfunded liabilities) ?

Is the BOJ trapped (20+ years of QE/debt monetization) ?

Is the SNB trapped (fighting a strong CHF vs EURO and USD by piling on billions and billions on their balance sheet)...

...

 

So I guess it's more of a rhethorical question - the fiat money debt ponzi system itself is the problem, no matter through which fiat currency you look at it. They all blow this ponzi - some a bit faster than others at some time, but they are all in it and there is no easy / painless way out of overindebtedness. Forward, Weimar World, the cliff is nigh...

 

Righttoarmbears's picture

There is a way out, its called a crash that the FED, ECB and just about every other global economy has spent the last 8-9 years trying to avoid, the financial elastic has been stretched further than ever before, and QE has just added extra strands, if/when it does go snap it could be apocalyptic for many nations.

the other option is more of the same money printing until we all end up like Zimbabwe!!

J J Pettigrew's picture

Zimbabewe, where they kill the white farmers and take their farm land....

Fireman's picture

Print you treacherous and rabid gold man sucks organ grinding monkey, PRINT!

 

Weimar days are here again. Who coulda figured apart from the Germans who are stacking nicely and patiently waiting for the EUSSR sewer to blow.

Forget those damn Blipcoins and such electric tulips that are about to get turned off. If it aint shiny and you don't hold it then it aint worth shit.

https://austrian.economicblogs.org/max-keiser/2017/keiser-german-investo...

brucyy's picture

I can never get enough of the terrified dragui's face .

It should be printed for every billboards of Brussel

nmewn's picture

His face should be on the €5 bill ;-) 

Chryoprase the Troll's picture

Surely you mean the €5 Billion Euro bill?

Hugh Mann's picture

Fuck the ECB! The sooner it rots the better off we will be. They're nothing but a bunch of crooks.

J J Pettigrew's picture

We all watched as the Central Planners / Bankers painted themselves into a corner, and asked for MORE PAINT.

The "theories" dont have a REAL exit strategy that will NOT undo what they have done.

Last of the Middle Class's picture

The weak Euro game is perpetuated by bankers that do not have to use the majority of their disposable income buying basic needs and services such as gasoline, rent, health care and others. It is for the stock holder class that benefits from the increased business and "competitiveness" of the weak currency. Those working daily for an hourly wage are deflated to insignificance while the owner class just buys more stuff with the fiat the ECB passes out. 

J J Pettigrew's picture

There are four groups in this country....come of which overlap

1. Those who got very rich off the stock market/ Fed Reserve over stimulation

2. Those who didnt.

3. Those who watch Fox

4. Those who watch MSNBC

SmittyinLA's picture

The ECB gets paid commissions on public debt

pndr4495's picture

The ECB bankers are too intelligent for the simple analogy that more pain is created by trying to remove a bandaid slowly rather than ripping it off quickly so the wound can benefit by some FRESH AIR.

olibur's picture

“... That the US always maintained a healthy secondary market alive ...”

Is that the Belgium Bulge?

All bollocks, all of it.

Nick Jihad's picture

I don't see why this is so complicated for some people. The ECB's stance is very simple: "There is no bubble, and we must not let it burst."

venturen's picture

keep feeding the spoiled children candy and they will never learn to behave 

VWAndy's picture

 Hangin a few bankers might do it.

VWAndy's picture

 His head would look pretty good on a stick. just an observation.

JailBanksters's picture

They could con more countries into the EU to be slaves to Germany

 

fonx's picture

"The European Union countries export mostly to themselves. Member countries sell more than two-thirds of their goods and services to other countries in the eurozone. Therefore, the more they export and their economies recover, the stronger the euro"

I stopped reading there. That is completely false. If the euro economy is endogamous and we consume our own product then the euro can't get stronger. It gets stronger when we sell to the outside and foreign countries have to get euros to buy from Europe.