David Keohane at FT Alphaville has a good piece up on non-performing loans in the euro zone. He highlights a chart from JPMorgan Chase that charts NPLs across three different areas within the euro zone: across the so-called periphery, in Germany and elsewhere in the eurozone
And then he also bolds this accompanying statement from JPMorgan Chase:
It is not surprising that the periphery is exhibiting a rising pattern in terms of NPL ratios. What is worrying is the speed of increase, at 2.5% per year.
When I see the chart for Euro zone NPLs and look at the numbers, I think debt deflation. And this is exactly the problem with the euro zone’s policy mix. Contractionary fiscal policy only invites more private deleveraging. And that is tipping countries with high private debt into a vicious debt deflationary cycle that vastly inflates NPLs and weakens the financial sector tremendously.
It was interesting for me that just an hour before I saw this chart, I saw via a Twitter link from another FT Alphaville contributor Simon Hinrichsen that Jeroen Dissjelbloem, the new Eurogroup head, came out with a statement this weekend on the policy mix that highlights Europe’s thinking. CNBC quotes Dijsselbloem as saying:
“Monetary policy can really not help us out of the crisis. It can take away the pressure, it can accommodate new growth. But what we really need in all countries is structural reforms in the first place.
“I’d just like to stress the point that in the policy mix of fiscal policy, monetary policy and structural reforms — I’d like the order to be exactly the other way around. Structural reforms in the first place, fiscal policy and viable targets in the mid-term for all regions in second place — and monetary policy can only accommodate domestic economic problems in the short-term.”
Notice that what Dijsselbloem is really saying is that he wants loose monetary policy to partially offset fiscal consolidation while structural reforms are implemented which will enhance medium-term growth. What Dijsselbloem is saying is that Europe wants a fiscal policy that is short-term contractionary but will partially offset this by a looser monetary policy, with structural reforms as the holy grail of longer-term growth – as they were in Germany (and the Netherlands until the crisis killed that growth).
Now contrast this to Japan.
In Japan, it is the same three pillars that define Abenomics: fiscal policy, monetary and structural reform. As I put it in my post on the Widowmaker trade last month, “If you want to use stimulus at all, then you need to have reform policies as well. It’s a three-pronged approach. The supply side matters. And that is the promise of Abenomics, isn’t it: fiscal and monetary stimulus as bridges to sustainable growth due to economic reform. Supposedly, this is what Abenomics is all about.”
In Japan, Abenomics loose monetary policy is used to enhance fiscal expansion while structural reforms are implemented which will allow medium-term growth to continue. See the difference? Japan’s policy mix is reflationary – with some like Kyle Bass intimating it is even hyper-reflationary. On the other hand, Europe’s policy mix is deflationary – with some like me and the other Edward arguing that it is even debt deflationary. The key difference is fiscal.
On monetary policy, however, just last night I saw the following on from David Beckworth about Abenomics quoting Lars Christensen:
the competitive devaluation arising from Abenomics may be the catalyst to kick start the ECB into more serious efforts if they care about the Eurozone’s external competitiveness. The ECB may ease to keep the Euro from getting too expensive and in the process shore up European domestic demand. How ironic it would be if Abenomics were to accomplish in the Eurozone what intense human suffering could not: moving the ECB to forcefully act.
We will have to see if that’s actually the case. Jeroen Dijsselbloem is saying just the opposite right now. The Eurogroup head is saying that fiscal policy will remain contractionary and that monetary policy should not be loosened any further to override this. Only structural reform will help in the long run.
If David is to eventually be proved right about the ECB joining the competitive currency devaluation party, it will be because the debt deflation now ongoing in the periphery also hits countries like the Netherlands where private debt is already creating a big problem despite the vaunted structural reforms of the past. As I warned members last year, (Dutch and) German policymakers don’t understand debt deflation. The policy mix will remain debt deflationary until it does engulf the Netherlands (and France). And then we will see what happens.