Europe - Short It: Monetary Policy Is A Non-Sticking Band-Aid

by: Enzio von Pfeil

Originally published on June 6, 2014

  1. Self-congratulatory politicians. Back on 21st May we already warned that the European "recovery" is a dangerous chimera. Indeed, according to a poll conducted the day before, business executives felt that the crisis is far from over. We agree. It's far from over because the self-congratulatory politicians are sticking their heads in the sand when it comes to structural reforms.
  2. Market recovery delusional. In psychology, a delusion is a "fixed false belief that is resistant to reason or confrontation with actual fact". Welcome to Euro-phoria, aka today's strong markets in Asia and Europe. The latter's politicians keep getting votes by promising that "if you vote for me, you need never work again. We'll just soak the rich and pay for your mega-holiday, which you are entitled to." So how can that business model of welfarism and thus asphyxiating taxes work? Why invest in plant, machinery and equipment in Europe if you are going to be taxed into extinction?
  3. Clogged market credentials. What is the best antonym for "free", as in "free" markets? We reckon: "clogged", if not "trapped". A certain Rod Price recently wrote a letter to the editor of the Financial Times, "The EU has deserted its free market credentials". He saliently notes, "Now, Europe is seen to be about social engineering and restricting markets. Labour markets are regulated through legislation like the working time directive. Markets are restricted by bans on short selling. The single market has ground to a halt, applying a modest range of manufactured products and financial services...Protectionist regulation abounds, driven by entrenched vested interests Europe spews out regulations at a desperate pace and has sought to apply ever greater influence over tax. Far from being tax cutting, it forces minimum VAT levels on member states and supports new taxes like the financial transaction tax...An ever greater bureaucracy had never seen a budget cut, or even freeze, until last year..." Why invest in plant, machinery and equipment in Europe if you are going to be strangled by jealousy, aka regulations and taxes, anyway?
  4. Politicians are scared of robots. As a telling sign of how malfunctioning Europe's policies have become, we read in yesterday's Financial Times that "Robot makers warned of fears that automation will steal jobs". Even though the EU is funding robotics research to the tune of €700 million (to be supplemented by another €2.1 billion from private industry), "Robot makers have been warned by Brussels that they must do more to reassure the public over concerns that a new wave of automation could take away jobs." We wonder: a) why robots in the first place, and b) is it robots, or politicians, who are killing jobs?
  5. Clogged monetary policy, too. Despite market euphoria re Draghi's moves yesterday, this delusional party hardly can continue. Here is what was announced: 1) stop sterilising the monetary consequences of its bond purchases under the Securities Market Programme; 2) cut rates (it cut its main refinancing rate to 0.15%, from 0.25%, and the deposit rate from zero to minus -.1%, meaning that banks will have to pay a fee for parking their cash at the ECB); 3) provide cheap loans of up to €400 billion for small businesses until 2018 (dubbed "targeted long-term refinancing operations", or TLTRO), and 4) prepare intensively for Quantitative Easing (via outright purchases of government bonds). This delusional party cannot continue because Europe has "welfared" its way out of a business cycle (see point three above): when dealing with structural slumps like we have in Europe, relying solely on monetary policy is like using a popgun on an elephant. Furthermore, negative interest rates have not worked before (see next): they neither have led to more lending nor have they boosted inflation via a weaker currency.
  6. Danish puff pastry. Denmark's Central Bank, Nationalbanken, was the first to introduce negative official interest rates. They lasted from July 2012-April 2014. Even if Denmark's goal of maintaining the Kronor's ((DKR's)) peg to the Euro differed from the ECB's of fanning inflation, history is a guide: Denmark's negative rates simply could not create higher lending, so the impact on the real economy was zero. Negative rates did not boost Danish lending because lending decisions are based on funding costs - and not on official interest rates. Besides, in Europe's case: why lend in order to invest in plant, machinery and equipment when corporates are going to be strangled by jealousy, aka regulations and taxes, anyway? And as regards inflation, once the Great Danes created negative interest rates it took some months for the DKR to skid an eye-popping 0.4%, from DKR 7.43 to 7.46 /€. Hardly the stuff of which imported inflation is made, n'est pas?
  7. Investment implications. The ECB's monetary policy is like using a popgun with which to slay an elephant. It is a band-aid without even the adhesive. So avoid Europe; once delusional drinks parties are over with and sobriety sets in, investors will seek more promising pastures. How about Switzerland or, indeed, China?