"No One's Ready For The ECB" - The Eurozone's Coming Debt Crisis

Authored by Daniel Lacalle via DLacalle.com,

The European Central bank has signaled the end of its asset purchase program and a possible rate hike before 2019. After more than 2 trillion euro of purchases and zero interest rate policy, it is overdue.

The massive quantitative easing program has generated very significant imbalances and the risks outweigh the questionable benefits.

The balance sheet of the ECB is now more than 40% of the Eurozone GDP.

The governments of the Eurozone, however, have not prepared themselves at all for the end of stimuli.

Rather the contrary.

The Eurozone states often claim that deficits have been reduced and risks contained. However, closer scrutiny shows that the bulk of deficit reductions came from lower cost of debt. Eurozone government spending has barely fallen, despite lower unemployment and rising tax revenues. Structural deficits remain stubborn, and in some cases, unchanged from 2013 levels.

The 19 eurozone countries have collectively saved 1.15 trillion euros in interest payments since 2008 due to ECB rate cuts and monetary policy interventions, according to Handelsblatt. A reduction in costs against the losses of pensioners and savers.

However, that illusion of savings and budget stability can rapidly disappear as most Eurozone countries face massive maturities in the 2018-2020 period and wasted precious years of quantitative easing without implementing strong structural reforms. Tax wedge rose for families and SMEs, while current spending by governments barely fell, competitiveness remained poor and a massive one trillion euro in non-performing loans raised doubts about the health of the European financial system.

The main eurozone economies face more than 2.1 trillion euro in maturities between 2018 and 2021. This, added to lower tax revenues due to the slowdown and rising spending from populist demands creates an enormous risk of a large debt crisis that no central bank will be able to contain. Absent of structural reforms, the eurozone faces a Japan-style stagnation or a debt crisis.

The ECB warned in 2014 that “many euro area countries did not take advantage of the favorable economic conditions prior to the crisis to build up a fiscal buffer for future downturns”. This is happening again, but much worse, as average debt to GDP has soared to almost 90% and government spending to GDP also remains above 40% with zero interest rates and massive asset purchases. The reality is that the ECB is left without tools to tackle a new crisis through money supply and rate cuts.

Where should bond yields be if the ECB was not the largest purchaser of Eurozone bonds? We do not know for sure, as there is no discernible secondary demand at these levels. At the peak of QE in the US, the Federal Reserve was never 100% of net issuances of treasuries. Today, the ECB program is more than three times the net issuances. This means we have no clue of what is the real market demand for eurozone sovereign bonds and what yields would be demanded by investors.

What we know is that yields would be massively higher. A minimum of 120 basis points above current yields would be needed to reflect the inflation expectations and bring yields closer to the curve.

Of course, the Eurozone nation would not feel the whole increase in expected yields. At the peak of the Euro crisis, Spain’s average cost of debt was 3.4% or almost 300 basis points below where yields rose. But the return of yields to normalized levels will likely affect confidence as the placebo effect of QE vanishes and reality returns.

No single country in the Eurozone except Germany, maybe The Netherlands, is ready for the end of QE.

Eurozone governments have spent all the benefits of QE in higher current spending and kept structural deficits. The entire improvement in net interest expense has been squandered in higher bureaucratic spending.

Now the tide is turning. Even if the ECB decides to delay the end of QE, the reality is that sovereign yields and credit default swaps have been quietly rising. Not just due to the Italian crisis, but due to the evidence of unsolved issues coming back to the surface in Europe.

The worst part of this is that governments in Europe will likely decide to increase taxes to try to tackle rising deficits coming from the evidence of the Eurozone slowdown in lower revenues and the end of zero-interest-rate policies in expenses.

The combination of the already clear slowdown with higher tax wedges, stubbornly high spending and rising deficits and rates can be a perfect storm for Europe that will likely bring back the ghost of the crisis.

Europe decided to tackle the crisis hiding imbalances under a massive wave of liquidity and governments abandoned all reforms to bet it all on monetary policy. Now, the reality is likely to show its face abruptly. And none of the governments in Europe is ready, because they are not even aware of the extent of the problem.

Comments

RibbitFreedom Wed, 06/13/2018 - 05:08 Permalink

“No single country in the Eurozone except Germany, maybe The Netherlands, is ready for the end of QE.”

 

Living in the Netherlands I’m glad they have a stable society, a lower debt to GDP ratio and a savings culture.

Will it matter when the day of reckoning comes?

Who knows! 

‘Someone’s’ savings will be bailed-in.

Heros NidStyles Wed, 06/13/2018 - 05:29 Permalink

The current 3 month Libor € is -.35%, while the CHF is at -.75%. 

This is NIRP, and any pension plan owning € denominated government debt has been plundered since the PIIGS crisis in 2010.

Dragi had to do this to prevent the EU from falling apart.  It was the only way.  The refugee crisis may well be the way the EU elites have chosen to avoid taking responsibility.

In reply to by NidStyles

pc_babe Adolfsteinbergovitch Wed, 06/13/2018 - 07:02 Permalink

Why should EU countries prepare or have prepared for a reckoning when you, Draci, neither asked or incentivized them to do so?

You have run worse than a free money shop 24/7 for the last 10 yrs

You and the EU Socialists have destroyed utterly the mechanism of price, risk v reward. And now you complain that the easy-money heroin addicts that you created won't and can't even pay for their own heroin.

Wasn't this the intent all along?

In reply to by Adolfsteinbergovitch

silver140 pc_babe Wed, 06/13/2018 - 08:12 Permalink

I wouldn't call parasitoid corporate fascist banksters "EU Socialists". The only possible use of the term "socialist" would be in regard to using public tax money for the enrichment of private banks and corporations and their parasitoid owners, and even then it would be a stretch, because really, it should be recognized as fraud.

A parasitoid is an organism that lives in close association with its host and at the host's expense, and which sooner or later kills it.https://en.wikipedia.org/wiki/Parasitoid

1. A deception practiced in order to induce another to give up possession of property or surrender a right.https://www.thefreedictionary.com/fraud

In reply to by pc_babe

Singelguy RibbitFreedom Wed, 06/13/2018 - 06:00 Permalink

I would suggest that the Netherlands appears stable but the social unrest is growing as a result of the migrant inflows which have exacerbated the housing shortage and the cost of social welfare programs. The housing that is available is already too expensive and a rise in interest rates will make it unaffordable for many. The near zero interest rates have threatened pension plans and punished savers. Under Rutte and the VVD, taxes now take almost 40% of GDP. 

You are probably right that “someone’s” savings will be bailed in. I would urge all Dutch people to keep as little cash as possible in the bank; enough to cover monthly expenses. Unlike the US banks, most of the European banks are still saddled with billions in bad loans. Deutsche Bank is the big black swan in the room. If it falls, the ripple effects will be significant. 

In reply to by RibbitFreedom

yvhmer RibbitFreedom Wed, 06/13/2018 - 06:22 Permalink

Agreed.

The question is what is being saved. .... Pension, mortgage and some savingsaccount.  

So far, with the job growth looking good on paper, the same issues with jobs in the US can be seen here.

1. Dislocation of costs of living with payment due to the creation of many low paying jobs. 

2. The cost of dwelling is increasing, meaning a bigger chunck of a lower wage is spent of the most essential item. 

3. Add to this that a growing group of Dutch find themselves in debt relief programmes supported by a dependency on rental aid, mortgage interest deduction, health care insurance premium "support". The latter is like this: if you still paid your premium timely, you get the support.  If not you get your premium realised by 50%, thus wrecking household budgets. 

4. Stacking collectioncosts despite legal reform. This is because the government is the worst stacker. Thus feeding the no3 issue. 

So, although it may sound nice, to have a sovereign debt situation < 60% of GDP, this is certainly not the end all argument. 

The Dutch debt has exploded from 200 billion to 500 billion plus in 17 years .......pointing to a systemic out of whack situation. 

In reply to by RibbitFreedom

Singelguy yvhmer Wed, 06/13/2018 - 12:32 Permalink

I have lived here for 7 years. I visited the Netherlands frequently over the past 30 years and the changes have been dramatic over the years. What blows me away is the housing situation. If you want affordable rental housing you have to register on woningnet.nl but it will be TWENTY YEARS before you get to the front of the line! This is even worse if you want to live in the area of Amsterdam. To add insult to injury, the refugees get put to the front of the line and the Dutch citizens have to wait even longer.

The Dutch debt will grow even faster as long as the migrant situation is not dealt with. At some point, the Dutch people will lose their patience, especially if taxes are raised further to cover the increasing debt service costs that are coming, while the government benefits diminish.

The good news is that most Dutch homeowners refinanced their mortgages in the past few years and are locked in for 8 years. Hopefully, the crisis will come and go in that 8 year period. 

In reply to by yvhmer

Money_for_Nothing RibbitFreedom Wed, 06/13/2018 - 07:03 Permalink

QE is a public-sector form of vendor-financing. Germany lends money to other countries to buy its (overpriced) products. Germany cannot allow prices to fall because they don't want changes in management. Prices can't rise or stay the same because debt is too high. EU and Germany are deficit in leadership and common sense (negative interest rates? bail-ins? really? weren't these tried just before ww2?). Luckily President Trump is giving them a way out that doesn't involve complete social collapse.

In reply to by RibbitFreedom

shovelhead Money_for_Nothing Wed, 06/13/2018 - 08:07 Permalink

Summary:

Cheap money is never a good idea even when the party's getting started. They all love it when the goods and loan profits come rolling in, but there's always a day of reckoning. Prices are supposed to mean something and they always do.

One way or another in the end.

Banks say "Save us or we'll take you down with us."

"Fuck me? No, fuck you. How you like them apples?"

In reply to by Money_for_Nothing

NidStyles Wed, 06/13/2018 - 05:09 Permalink

The other day I had some schlomo try to convince me that Jews were a hybrid creation of the true owners of Earth, the early hominids like as they suggested;Sasquatch and an alien race that might as well be God. 

Just sharing, because it’s more relavant than this bs article.

 

This is the crap they are teaching their kids, and to further it they are telling them that since they are closer to the hominids they have a greater right to be in charge of everything that occurs here on the planet. That is literally their own justification for their behaviors now. 

As if evolution didn’t mean the most recent of the human family weren’t somehow the most advanced. 

Money_for_Nothing wonger Wed, 06/13/2018 - 07:23 Permalink

The way it works is bonds stay at 0 and price inflation goes to 10%. Then you get truckers striking. Brazil today. Called lorry strikes in EU. Last happened 2015? EU bonds are full faith and credit of Brussels.

People stop having the money to buy bonds when interest rates go below real-price-inflation-rates. Slowly at first then rapidly.

In reply to by wonger

chubbar wonger Wed, 06/13/2018 - 07:24 Permalink

I read an interesting study that rates can't really go below -0.7% without triggering cash hoarding, etc. This means it has to be a cashless society, which means wholesale looting by TPTB, if not in the short run then in the long run. Which is why we have to fight any form of cashless type payment system as it is likely a ruse by the bankers.

On a larger note, to me it looks like a coordinated effort to crash the whole system at once. I wonder what is on the other side when assets (debt) turns out to be worthless?

In reply to by wonger

Sudden Debt Wed, 06/13/2018 - 05:55 Permalink

The massive stimuli have created massive inflation and reckless spending which caused an increase in tax revenue.

Countries can now spend more because of this.

So when the economy slows, they'll be in a world of hurt.

And debts have been growing year over year non stop.

 

The ECB won't stop. Maybe for a short while.

 

and the cat is already out of the bag. Inflation is here and destroying the purchasing power a great deal. 

So they'll need to increase wages, which asks for more credit and thats why the cycle will and can't stop going to hyperinflation.

Singelguy Sudden Debt Wed, 06/13/2018 - 06:08 Permalink

The inflation is mostly in housing and equities. The rise in taxes have diminished consumer’s disposable income so there is little price elasticity. The ECB may not stop until they have no other choice. If Italy collapses, the ECB does not have the wherewithal to bail them out. Confidence in the euro will collapse and interest rates will skyrocket. That will lead to a collapse in housing prices in the northern EU countries. Wages are unlikely to rise. Youth unemployment remains high throughout the EU. If governments raise minimum wages, businesses are likely to close up or move elsewhere. You are right; there is going to be a world of hurt.

In reply to by Sudden Debt

Money_for_Nothing Sudden Debt Wed, 06/13/2018 - 07:57 Permalink

Cut immigration. Raise social spending less than price inflation. Raise wages. Automate. Spread ownership of automated factories around so that people retire and live off income generated by automated factories. Building automated factories increases employment. Running automated factories decreases employment. Important that Citizens own automated factories. Important that Citizens are formed into a well regulated militia to deter invasion by trading partners.

In reply to by Sudden Debt

adonisdemilo Wed, 06/13/2018 - 06:10 Permalink

Looks like it's imploding and the sooner the better.

Beats me how the UK can't see off this bunch of amateurs.

Oh, I forget, we've got quite a lot of traitors entrenched in the Civil Service as well as the Government. 

Roger Ramjet Wed, 06/13/2018 - 07:06 Permalink

There is no way that the ECB can reverse course with its current policy.  The only way that it will end is when market forces ultimately prevail and force an involuntary change.  Draghi will provide some lip service to the issue, but always leave an option to continue its current policy.

Let it Go Wed, 06/13/2018 - 07:12 Permalink

The idea that the bond market is a bubble about to pop is a subject not to take lightly. This matter has been scrutinized many times in recent years and little has really changed except debt has grown much faster than the economy in general.

The so-called experts such as Paul Krugman in the ivory towers of academia in many ways pose one of the greatest threats to our economic stability in that they often fail to see potential second and third order effects of debt monetization. The article below delves into why bonds could be a trap that strips investor of their wealth.

 http://Bond Market Stability Must Again Be Questioned.html

Herdee Wed, 06/13/2018 - 08:13 Permalink

Negative interest rates and massive fiat currency printing to provide liquidity will keep going. Just see what happens to thr risk of all debt worldwide when the U.S. Dollar increases to new highs. It'll squeeze the livin' piss right out of everybody.

Balance-Sheet Wed, 06/13/2018 - 11:40 Permalink

Given the 100s of millions (billions?) that do not, cannot, will not work there is no real alternative to creating electronic credits and distributing them. The gravest danger lies in trying to return to mid 20th Century financial approaches.

Given the experiments in organized mass murder at he same time forced liquidations of the economically redundant is unlikely to be politically tolerable.