Submitted by David Stockman's ContraCorner
"Now We Are At The Lower Bound": Draghi Reaches The Dead-End Of Keynesian Central Banking
Europe is not growing much because most of its economies have been crushed under a mountain of debt, taxes, welfarism and statist dirigisme. Yet somehow the foolish pettifogger running the ECB thinks that driving the cost of money to the “lower bound” (i.e. zero) will help overcome these insuperable—and government made—barriers to prosperity.
Yet in today’s financialized economies, zero cost money has but one use: It gifts speculators with free COGS (cost of goods sold) on their carry trades. Indeed, today’s 10 basis point cut by the ECB is in itself screaming proof that central bankers are lost in a Keynesian dead-end.
You see, Mario, no Frenchman worried about his job is going to buy a new car on credit just because his loan cost drops by a trivial $2 per month, nor will a rounding error improvement in business loan rates cause Italian companies parched for customers to stock up on more inventory or machines. In fact, at the zero bound the only place that today’s microscopic rate cut is meaningful is on the London hedge fund’s spread on German bunds yielding 97 bps—-which are now presumably fundable on repo at 10 bps less.
Needless to say, when your only tool is a hammer, everything looks like a nail. And when you are a Keynesian with a hammer, it is presumed that nothing much was hammered before yesterday. That is to say, the whole mindless drive by the ECB toward the zero bound, which Draghi pointedly claimed to have achieved this morning, presumes that balance sheets—–the accumulated record of past actions—don’t matter.
Instead, its all about the credit “flow” today and tomorrow. Accordingly, lower interest rates—no matter how trivial the change—are ritualistically presumed to stimulate more borrowing in the real economy, and therefore more spending, income and virtuous circle of Keynesian growth.
Earlier this week I posted a chart on household debt growth in Portugal which had soared by 6X in the decade before the financial crisis compared to nominal GDP growth of 2X. Self-evidently, the household leverage ratio had escalated into uncharted territory, perhaps explaining why Portugal’s economy is struggling under the burden of “peak debt”.
And, yes, Portugal is an outlier—–the victim of getting German borrowing rates on Greek economic habits. But it aptly illustrates the futility of pushing credit on a string when balance sheets are already saturated with debt.
The Italian economy was in the debt pyramiding business much earlier, of course, but the same point holds true. As shown below, in just the eight years leading to the 2008 financial crisis, credit advanced to the private sector (households and business) nearly tripled, rising at a 10% CAGR during that period compared to nominal GDP growth of barely 3% per year.
Since 2008, by contrast, credit growth has flat-lined, but surely not because interest rates were too high. The self-evident problem is that debt and leverage were too high; the debt fueled boom after the euro was inaugurated simply consumed all the balance sheet runway that was available.
Now the Italian economy must grow the old fashion way. That is, not through credit fueled spending but via supply side expansion in the form of investment, enterprise and more labor hours and labor productivity. And precisely what can the the monetary central planners in Frankfurt do about the latter?
Indeed, peak debt is a problem throughout the Eurozone. In just 9 years the household leverage ratio in Spain, for example, nearly doubled from 55% to 93% of GDP. Since the crisis, it has been slowly receding, but, again, that is not a sign that Europe’s miniature interest rates are too high; its evidence that the Keynesian debt trick—-the one time ratcheting of leverage ratios—is over and done.
So getting (finally) to the zero bound leaves the ECB high and dry. In the near-term, today’s actions will simply accelerate the exchange rate reversal, and thereby erase the “deflation” hobgoblin that the ECB has used to justify its destructive financial repression.
Between Draghi’s mid-2012 ukase and this past April, the euro rose from 120 to 140 or 17 percent. And that’s how the inflation rate of goods and services in the Eurozone temporarily dipped from its historic 2% path to the most recent y/y reading of 0.3%.
But this wasn’t a calamity; nor was it permanent. It was just a measure of the degree to which the price of imported raw materials and finished goods—of which Europe records $2 trillion annually from the rest of the word—-had abated in euro terms. Factory gate prices, for example, are down 1.1% in the LTM period, and that’s precisely because imported production inputs have been cheaper.
But the euro has already crashed through 130/USD and will be heading back to 120 in the months ahead. With perhaps a few months of lag, the euro area CPI will rebound and the deflation myth will have been long forgotten. Yet when the CPI regresses toward the ECB’s own target—just under 2%—-the rubber will surely meet the road in Frankfurt.
The only possible way that the Germans could have been hornswoggled into QE was on monetary grounds—that is, the onset of a “dangerous” bout of long-lasting deflation. But when the euro gets back into its weakening groove, inflation will get back to its historic path. So just where is the beef?
Not only that. A weakening euro will also accelerate a reversal of the hedge fund hot dollar flows into peripheral country debt that has occurred since mid-2012—-meaning that yields on Italian, Spanish, Greek and Portuguese debt will soon be marching back up the hill. Indeed, as the hot dollar bid vacates the market, the fellow-traveling commercial banks in the peripheral countries will find that perhaps they gorged too greedily on their own sovereign debt. And if they too begin lightening the load……well, its going to take more than “whatever” to stem the tide of selling.
Having arrived at the zero bound, Mario Draghi will thus find that he doesn’t remotely have “whatever it takes” for the next round. Inflation will be back. QE will be off the table. And european growth will remain hostage to debt, taxes, welfare and dirigisme.
But as a long-time servant of the Italian state, he should have known that all along.