Policy options in Europe look frightfully limited
Despite, the high cost of gasoline/petrol in Europe due to tax, the fact that Europe is a large net importer of oil means the decline in oil price will be more of a boost for that continent than it is to North America where concerns about oil capex run deep. I think Japan and Europe will be the big winners of the great earnings shift associated with the net win for oil importers. But, that’s the only lift I see in Europe beyond the basing effect ongoing in the periphery. The quantitative easing route to stimulus has lots of hurdles to clear. Some thoughts below
First, on the win for Europe and Japan, I spoke to Warren Mosler about this on Friday. That discussion aired Friday and yesterday in two shows I hosted for Boom Bust. See here and here. Warren agreed with me, especially about Japan being a net winner here. But Europe should win too despite the fact that prices at the pump will not fall as steeply as in the US, due to high taxes. And even though we are seeing downward revisions for Europe and Germany right now, those numbers were well known. Bundesbank head Weidmann has acknowledged that if oil prices stay at these levels, there will be a boost that means 2015 GDP projections will have to increase from the present low levels.
This is the only real stimulus we are going to see here, though. Elsewhere, there are political, legal and market constraints everywhere you look.
This morning, I ran across two articles on the ECB’s covered bond/ABS program that implied it would not be effective. Before I get into these articles, let me remind you what I wrote in October when these measures were introduced:
“Personally, I am sceptical about the over-reliance on the ECB to give Europe a boost, when private debt in periphery is high. There will be distortions. And piling on more private debt without concomitant thought to wage growth is not a lasting solution. Now, Italy doesn’t have a private debt problem. So this program is tailor-made for that economy. But the rest of the periphery still has elevated private debt levels. And France is on the cusp of debt deflation becoming a real threat, with its housing market suffering the same downward trajectory we saw in the Netherlands.
“The French example highlights the real problem here. The new Jean-Claude Juncker headed-EC is said to be poised on rejecting the French 2015 budget proposal as not sufficiently austere (link in German). This is a key test for Juncker and he plans to show that despite the relaxation in austerity time frames, the EC is only willing to backload austerity so far. The prevailing paradigm, in Euroland, therefore is still one in which the primacy of monetary policy remains. Fiscal policy is restrictive and monetary policy is therefore being used to steer economic policy to deal with cyclical shortfalls.”
But how effective can this monetary policy be in a balkanized eurozone asset market? Here’s what the papers are saying. First, the Wall Street Journal via a story the WSJ’s Katie Martin pointed me to:
The European Central Bank is facing a big Catch-22.
The central bank is buying certain types of bank debt as part of its efforts to animate the drab eurozone economy by expanding the size of its balance sheet.
Problem is, that has already boosted the price of these bank bonds.
And now those bonds are so expensive, that normal investors don’t want to buy them. So fewer bonds are getting issued, and there’s not enough for the ECB to buy.
Welcome to Europe.
Wednesday, the plan took a further blow, as AIB, an Irish bank was forced to scrap a sale of secured bonds amid a tricky week for bank-bond issuance that had already seen Nomura and a unit of Santander shelve plans for selling unsecured debt.
Wednesday’s canned deal may increase calls for the ECB to expand its asset purchases, known as quantitative easing, to include government bonds.
Corroboration comes via the FT, where they report the ECB is also getting blamed for a shortage of covered bonds:
Covered bond supply has reached its lowest level in nearly two decades as the European Central Bank has been accused of crowding out investors from the market by pushing up prices and depressing yields.
Since Mario Draghi, ECB president, announced plans to buy up to €1tn in covered bonds and asset-backed securities, yields have tumbled to record lows. At the beginning of September the average covered bond yield stood at 0.7 per cent after falling below 1 per cent in June, according to an index from Bank of America Merrill Lynch. Yields currently average 0.53 per cent.
Last month Allied Irish Banks took the unusual step of postponing a planned 10-year covered bond deal amid market speculation that the yield offered was too low to tempt investors.
“Buying covered bonds is not the silver bullet that will drive Europe out of the deflationary spiral,” said a London-based debt banker. “It does point towards sovereign QE.”
This is why we have been hearing so much about sovereign QE then. The covered bond program is too small and is having too distortionary an effect on the market to work, just as I was saying in October. The problem is that sovereign QE has high political (and potentially high legal) hurdles to overcome. The Germans are dead set against it. Both Jens Weidmann and Sabine Lautenschläger, the two German ECB representatives, have voiced extreme opposition to a sovereign QE program.
Yet I am hearing from the German-language press that, not only are we likely to see sovereign QE, potentially as soon as January, but the ECB may well considering a sovereign QE campaign that is not proportional to GDP. Germany’s FAZ says that the debate in the ECB is now around a program that would be bigger than the publicly-debated 1 trillion euro program. And it will have to be non proportional to be effective (link in German here). According to the FAZ, the advocates of this program are looking to have it decided already by the ECB’s next meeting on 22 January. The FAZ says that Weidmann and three others are opposed to the program. But the decision to buy bonds does not have to be unanimous. So, the work now is around getting them onside so as few negative votes come in as possible. Of course, the Germans could also resign in protest. And that would be huge, marking a fatal split in the euro zone’s political cohesion. According to Austrian daily Wirtschaftsblatt the Austrian central bank head Nowotny is not opposed to sovereign QE (link in German). So he is not one of the four.
Now, recently Angela Merkel has made waves by wading into French and Italian internal politics and saying their reform efforts were insufficient. So the split here would be that much greater if the German ECB members were to resign. Given the fact that Merkel is a German politician without a European-wide mandate, this is a significant faux pas in my view. You could never imagine the Helmut Kohl described in Vermächtnis, the book I just finished reading, doing that. France’s Finance Minister Michel Sapin warned against this kind of thing because he says it plays into the hands of Marine Le Pen and other anti-Euro populists. He praised Wolfgang Schäuble for showing the right attitude in this regard. But the damage has been done and I see a split developing politically as the Germany today is a more self-interested country than the Germany that joined the eurozone.
At the same time, everywhere you look, the Eurogroup is coming down hard on budgets. This isn’t just France and Italy but everywhere where debt and deficits are high. Belgium’s budget is not getting a full backing from its European masters (link in Flemish). Spain doesn’t get the full backing for its 2015 budget from its European masters either (link in Spanish). And Portugal is getting the exact same treatment too (link in Portuguese). Right across the board, we are seeing a crackdown on budgets where the Maastricht 3 and 60 hurdle is not being met. And this explains Germany’s hawkish stance on its budget. It has to be disciplined to encourage the others.
I don’t see this working over the long term. Europe’s cohesion is extremely frayed right now and we are lucky that we are not in a crisis situation or there would be trouble. The rise in periphery bond yields that we saw in October was the beginning of the second round of the sovereign debt crisis. The decoupling we saw there, however, has since been walked back everywhere except Greece, where crisis is indeed brewing, with Syriza potentially coming to power next year. I think Greece can be isolated as a separate case but the still elevated yields in Greece are a sign that it cannot escape the Troika’s grasp and that sets up a political conflict that is where the second round of crisis will begin in earnest.
The question is two-fold. First, who will run Greece and what political remedies are Greece and the Troika going to find? If Syriza come to power, they may be less willing to fall into line and we would be faced with the potential for restructuring or more draconian outcomes. Second, when the budding crisis in Greece becomes more acute, will the Portuguese, Spanish and Italians remain recoupled to the core or will they decouple again as they did in October? Draghi is hoping non-proportional sovereign QE will keep things in line in Italy, Spain and Portugal. But at the same time, a large non-proportional sovereign QE program is a political firecracker. The fireworks are just beginning.