Citi On Whether Europe Can Ruin The World; Or How To Use An Insolvent Continent As An Excuse For Global Printing

Tyler Durden's picture

While Citi's Stephen Englander does not go as far as concluding that a collapse of Europe would be sufficient (but certainly necessary) to "ruin" the world, he does have a very relevant conclusion in a piece just released to clients: namely that central banks everywhere, but in Europe, are using the recessionary slow down in the insolvent continent, which nobody seems to believe any more will be able to avoid a recession (an event which S&P stated in no uncertain terms would lead to a downgrade in France and other core countries), as the perfect political smokescreen to push the turbo print button on their respective money printers. To wit: "Eurozone weakness has also generated indications that policy will be eased elsewhere (even if not in Europe). Policymakers in the US, UK and elsewhere [ZH: and Japan as of 2 hours ago] are using the euro crisis as cover to ease policy. For example, the FRBNY's Dudley yesterday characterized even the improved US numbers as disappointing and pointed to further measures if growth did not improve. Chinese growth targets and policy maker comments imply that measures might be taken if there is any sign of slowing. The BoE has already expanded it QE program. At a minimum the comments are suggesting that the policymakers are willing to take aggressive action to offset any weakness. Overall the bias towards stimulus appears to remain in place outside Europe." What is supremely paradoxical is that with the ECB stuck, any incremental QEasing by the world will merely result in an ever stronger euro, until exports by Germany become almost as impossible as those of Switzerland pr peg. As a result, organic European growth at whatever remaining centers of productivity and commerce will be truncated until it is gone completely, even as the EURUSD approaches 2.00, as the Fed embarks on what will be by then something between QE5 and QE10. And there are those who wonder why gold makes sense not only here, not only at $1570 a month ago, but at $1900 under two months ago...

From Citi's Stephen Englander:

The downgrading of euro zone growth rates has led to concern that euro zone economic weakness will derail global growth. For FX, a global downturn driven by euro zone weakness would dramatically change the prospects for risk-correlated G10 currencies along with EM currencies.
 
We think these concerns are significant, but are probably somewhat overstated. Europe matters and the direct effect on global GDP from a likely drop in European imports will matter. However, there are other forces that could matter more. We think the major threat from Europe is through financial markets and financial institutions in the event that no adequate resolution is reached to the euro sovereign debt crisis, rather than from the direct demand effects.  However our economists and we expect that the euro zone leaders will cobble together enough of a solution to keep the worst from happening on the financial side, even if the comprehensive solution still eludes them.
 
First consider the bad news:
 
1) Figures 1 and 2 show EU imports from the US as about  1 3/4% of US GDP and 5 1/2% of China GDP. In 2009, EU GDP dropped 4 1/4% in 2009 and the drop in US exports to the EU  was about 0.5% of US GDP; the drop in Chinese exports to the EU was about 1.5% of China's GDP.  Such a drag to growth is perceptible, although far from the worst problems these economies faced in 2008/09 or are facing now.
 
Also, a 4% GDP drop in the EU is well below what our economists and other analysts expect so far. European policymakers would have to make a bad situation a lot worse to for the global growth impact to be truly first order.

2) The other side is that the weakness in the euro zone is not happening in a vacuum. Figure 3 shows that as sovereign risk spreads have driven euro zone rates up (and are contributing to the slowdown in the euro zone), they also have driven rates down elsewhere in the world. So as was the case in 2008/09, the sharp drop in demand in hard-hit countries is driving liquidity provision elsewhere. This is crowding-in, however imperfectly. At a minimum the rate drop will serve to mitigate the external demand impact of slow growth in Europe.

3) Eurozone weakness has also generated indications that policy will be eased elsewhere (even if not in Europe). Policymakers in the US, UK and elsewhere are using the euro crisis as cover to ease policy. For example, the FRBNY's Dudley yesterday characterized even the improved US numbers as disappointing and pointed to further measures if growth did not improve. Chinese growth targets and policy maker comments imply that measures might be taken if there is any sign of slowing. The BoE has already expanded it QE program. At a minimum the comments are suggesting that the policymakers are willing to take aggressive action to offset any weakness. Overall the bias towards stimulus appears to remain in place outside Europe
 
It may seem paradoxical to argue that risk will be bought when the EU's expected contribution to global growth is being downgraded. However, as we have seen over the last two years, Newton's third law should be modified to 'every negative shock generates an equal or stronger policy response', so we would still argue that the few currencies with attractive fundamentals will be bought, even if the mechanical arithmetic of growth points otherwise.