The Rotten Eurozone's Dead Cat Uncertainty Principle

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by: Adam Whitehead
Summary

The smaller Eurozone nations warn Germany and France to take them seriously.

European politics has degenerated to the level of mob rule.

The Eurozone dead cat bounce is not a recovery.

The EU tries to convince Germany that its future is exporting to Eurozone nations rather than to the non-Eurozone global economy.

“Rehnfeld’s” fork in the Eurozone’s future path is less painful for the bloc, but more so for MarioDraghi.

(Source: AZ Quotes, caption and editing by the Author, sagacity by T.S. Eliot)

The true state, of what was referred to as "rotten" in the Eurozone, has become clear as elections for the top jobs commence. European Council President Donald Tusk, a Polish native, made it clear that France and Germany should take their hands off the steering wheel. Quite simply if they do not, then the smaller peoples of the continent will revolt. France and Germany thus now face popular rebellion at home and also on their borders.

(Source: Bloomberg, caption by the Author)

As an example, of the rottenness in the smaller nations and the ramifications for economic policy, the case of Lithuania is instructive. Presidential elections are now ongoing and the ugly truth, about this formerly EU cited exemplary model of performance and behavior, is plain to see. The nation has the second highest wealth inequality gap in the Eurozone. It also has the highest inflation in the Eurozone, making the cost of living for the poorest amongst the highest in bloc. One in ten Lithuanians don't even have indoor toilets. German enforced structural economic reforms have divided the nation. Demanding more structural reforms just looks cruel. Nothing is working for Lithuanians any more, not even money-laundering and the black economy.

(Source: Bloomberg, quote by Alexandre Ledru-Rollin)

The country's ECB Governing Council member Vitas Vasiliauskas is facing the sack. The reasoning offered for his termination, is that he has not done enough to address the economic problems of the country since the GFC. Blindly following the German and French line has got him to this point. His replacement will clearly have a Lithuanian agenda.

Obviously the Germans and French will talk up Russian active measures, but this doesn't matter to Lithuanians living in the moment without proper sanitation. The ECB and the EU have been lecturing Lithuania and its Baltic neighbors, about being economically inefficient money-launderers, thereby totally missing the real issues in these nations. The Eurozone experience for Baltic States has been one in which the Elite and Organized Crime grabbed all the spoils. Ironically, many of this Eureaucracy were for former Communist Apparatchiks.

The problems are not limited to the Baltic however. They stretch all the way to the Mediterranean and the English Channel.

Never one to miss an opportunity, to push the fiscal envelope in times of general Eurozone chaos, Italian Deputy Premier Luigi Di Maio has also pitched in for the little Eurozone guy. He would like the EU to look at all ways possible of granting his country the freedom to breach Stability Pact rules.

Even the Greeks are back, from their recent debt purgatory, pushing the Eurozone fiscal envelope again. This time around they hope to raise welfare spending and cut taxes simultaneously.

(Source: SkyNews, caption by the Author)

The rebellion, against the EU by Britain, has also caused what used to be the more civilized members of the polity to employ the language of the mob. The urbane Lib-Dems now use "Bollocks to Brexit" as their fighting brand strap-line.

(Source: AZ Quotes, caption by the Author)

European emotions run high and civility runs low, just at a time when President Trump is raising the global stakes with China. When he has burned those Trans-Pacific bridges his flame and ire will turn to Trans-Atlantic ones. He may find that they have already been set on fire by European partisans however.

The paucity of economic strength and good news has forced those, who try and control the Eurozone's future by controlling its history, to new levels of creativity. This creativity now verges upon the strange world of Quantum Theory; where anything is possible and things happen simultaneously and spontaneously. Today's dead cat bounce is tomorrow's economic expansion. In reality, both perceptions are held in the same moment in Mr. Market's eye and his price discovery. In reality therefore, the Eurozone real economy has gone nowhere; yet Mr. Market believes that it has been somewhere until he realizes that it has not.

(Source: Bloomberg, caption by the Author)

Whilst the markets tried to celebrate, the fact that Q1/2019 in the Eurozone ended up being better than anticipated, some members of the ECB were having none of it. Vice President Luis de Guindos made no reference to this data reprieve. Instead, he was anxious to signal that the low interest rate environment will remain in place for the foreseeable future. Consequently, he believes that banks should merge; in order to address this structural low interest rate environment with economies of scale.

(Source: Bloomberg, caption by the Author)

This refusal to be cheerful may have something to do with the ECB's forecasts for the foreseeable future out to 2021. After recovering in Q1, the Eurozone economy is expected to flat-line for the next two and half years. The recent rise in Eurozone inflation is therefore a headwind, since it is not accompanied by a sustained rise in GDP.

Soon to be ECB Chief Economist Philip Lane has his eyes fixed firmly on the post-bounce foreseeable future that he will inherit. Surveying this unenviable legacy, he commented that it is imperative for the market to understand that the ECB still has a few monetary policy easing tricks left up its sleeve. He also called upon fiscal policy makers to roll up their sleeves and join the future.

(Source: Author, caption by the Author)

The last report concluded that the ECB will ultimately ride out to save its dirigiste besiegers.

(Source: FT, caption by the Author)

As the latest economic data has failed to lift the siege, press campaigning has begun for the ECB to build bridges with national governments. It remains moot as to whether these bridges will be used by the dirigistes to assault the ECB, or by the central bank to save them.

Germany was noted in the last report, going AWOL on its Eurozone economic obligations by, adhering to a strict fiscally neutral response to its slowdown. Its Eurozone partners would like it to embark on a deficit financed fiscal stimulus of its own, in addition to turning a blind eye to their own deficit financed responses. Italy is already signaling that it will be breaking Stability Pact limits with its next budget, so the pressure on Germany to turn a blind eye is already academic.

The EU stepped up the pressure on the Germans to honor their obligations, to the nations who have bought their exports. The EU recently framed its own gloomy forecast for the Eurozone, in a specifically German context, in order to gain the latter's attention. The EU has now cut the German economic outlook, on the basis that its exports to its Eurozone trade partners will contract.

The EU thus wishes to frame the Eurozone, rather than the global economy, as Germany's economic salvation and future meal ticket. This may then prompt Germany into a larger deficit financed fiscal stimulus. In addition, it may also draw Germany into line in upcoming EU trade negotiations with the US and China. Finally, it will align Germany's interest in the Brexit outcome closer to that of the rest of the EU.

All this pressure has not fallen completely on deaf German ears. The Bertelsmann Foundation recently produced some pro-Eurozone research, which showed that the wealthy German Lander have been the major beneficiaries of the single market and single currency. Whilst ostensibly pro-Eurozone, this kind of publication is double edged; and may provoke the kind of sentiments in Germany that were found in the Brexit movement in Britain. The Bertelsmann picture of Germany is one of a Wealthy Europhile Elite versus a Poor Europhobe Lumpen Untermensch dialectic. Highlighting the blessings of the Europhiles only inflames the Europhobes.

Germany's reaction, in responding to its dialectically opposed pressurizers, is a pecuniary one. The current economic slowdown has in fact pushed Germany into fiscal deficit. This deficit will rise to about 100 billion Euros, by nature of falling tax revenues, in 2023. Germany's "Black Zero" fiscal strength is a myth. If President Trump is as cruel with the EU as he is with China, this deficit could rise significantly higher. Germany is in deficit and must now change economic policy to manage its dwindling fiscal resources. This will leave very little for its Eurozone neighbors.

The reaction to the dead cat bounce, by two men who would be ECB President, neatly illustrates the dichotomy facing the Eurozone. They also represent a diverging fork in the road for the Eurozone economy, conditional upon their views of the bounce.

Jens Weidmann is playing the bounce 100% the German way, as one would expect. He believes that the bounce is an opportunity to get the ECB's monetary policy normalization back on the road. A Eurozone future, down his fork in the road, is one where budget restraint and economic restructuring is enforced. More QE is verboten! ZIRP/NIRP tiered interest rate mitigation for the banks is also verboten. This implies further zeal to get back to normalizing soon. It will not go down well with the smaller Eurozone nations and will lead to greater political instability in the bloc.

Greece is already a long way down Weidmann's fork in the road, which is why it is so keen for to get a fiscal break. The Greek dead cat bounce is predicated upon reforms which see Greek living standards continually falling in order to right-size its budget. Parts of Italy, Spain and Portugal are also some way down this same fork; and similarly looking for a reverse. The populists, in all these countries, have been the main beneficiaries of this trip. The French are being driven down this same fork by Macron. In France, Yellow Vest manufacturers and retailers have been the real winners.

(Original photo: eonline, editing and caption by the Author)

"Rehnfeld's" fork in the road is more uncertain and leads to further Eurozone introspection. There is uncertainty over the longevity of the bounce and also the weak conditions from which it launched from. The normalization therefore remains on pause, indefinitely until there is some clarity.

"Rehnfeld's" fork is by default more palatable to the Eurozone Project, under its current conditions of economic and political trial by fire and populism respectively. In his own understated way, he is already building bridges with national capitals. From a career perspective, "Rehnfeld" is more palatable to Eurozone policy makers than Weidmann as the next ECB president.

(Source: Bloomberg, caption and editing by the Author)

"Rehnfeld's" stealthy climb to the pinnacle of the organized crime syndicate, through the ranks of national central bank bosses who control the Eurozone racket of money creation, has finally received its first major blow.

(Source: Author, caption by Tacitus)

A previous report noted "Rehnfeld" taking the step of silently stabbing boss of bosses Mario Draghi in the back, with his call for a monetary policy framework review. It was noted that said review is in effect a statement of Draghi's failure.

(Source: Bloomberg, caption by George Orwell!)

Evidently, outgoing Chief Economist Peter Praet feels "Rehnfeld's" dagger in his own ribs; and is anxious to preserve his own dubious legacy and track record. Praet recently started the resistance to "Rehnfeld", by calling into doubt the need for a review. Interestingly, his principle reason is that the review implies that the ECB is failing.

To deflect criticism, Praet is now using his valedictorian guidance to blame Eurozone politicians for the failures that are being affixed to the ECB. He recommends that now is the time for the politicians to pull together; to press ahead with legislation for deeper fiscal and economic integration.

Praet and Draghi would like the dirt, over the current failure of monetary policy to sustain growth and inflation, kicked under the ECB's carpet for posterity. Leaving it out in the open, only encourages the populists. Clearly the next ECB President will be politically appointed, by those who wish to keep both the Eurozone Project alive and reputation of the ECB unsullied. "Rehnfeld" will have to demonstrate that he has these credentials in spades going forward. Shafting ones antecedents is simply not European enough!

On the subject of tiered interest rate risk mitigation for the banks, Praet was careful to give this matter a clear monetary policy context. For him, it can only be considered if a monetary policy framework justification for it is involved. Praet correctly identifies the obvious fact that the banks are the primary transfer agents of ECB monetary policy decisions. Any talk of mitigating their interest rate risk should take this fact into account.

Thus far, the banks have been lending to all and sundry at eye-popping lending growth numbers. The main problem with the transmission mechanism, is that borrowers just do not wish to avail themselves of any loans at these attractive rates of interest. The transmission mechanism is not broken. The ECB and the banks are just pushing on a string. There is no pull from borrowers; well at least the solvent ones. The Eurozone borrowers and consumers are broken.

The German financial regulator (Bafin) is also on the lending investigation case. It is finding that there has been an erosion of lending standards, along with reduced risk provisioning. The evidence suggests that the German banks have been lending with gay abandon to anyone who wants to borrow, without paying enough attention on the borrower's ability to pay.

If the German banks therefore want risk mitigation, they are being cheeky. All they are really asking for is some further subsidy to their risky lending culture. Tiered interest rates may therefore make the risky situation in German banking even more so. Bafin would seem to be an advocate of the end to monetary policy easing, rather than simply advocating against tiered risk mitigation measures.

Mario Draghi chose to respond to his would be detractor rather more obliquely than Peter Praet. Selecting the forum of the Generation Euro Students' Award ceremony he fired a warning shot across "Rehnfeld's" bows. This shot came in the form of Draghi's statement that the ECB cannot accept defeat on the inflation target. Such a defeat would lead to a rise in real interest rates, which would act as a significant economic headwind. If "Rehnfeld" calls Draghi a failure, then Draghi will call him a defeatist.

Governing Council member Ardo Hansson is keen to avoid the controversy that a monetary policy framework review will create. He evidently sees that this will undermine the ECB's credibility and actions going forward. With this in mind, he is playing for time and kicking the review can down the road. He therefore cheekily says that he can see the "green shoots" of recovery and would therefore kick the review can a few moths further down the road. The tiered interest rate mitigation debate is a further distraction for him, which he refers to as "over-engineering". He much prefers to maintain the status quo and maintain the pretense that TLTRO III is a transition step towards monetary policy normalization. One wonders if any of his relatives were in the band that played on the Titanic!

US Commerce Secretary Wilbur Ross recently announced that the next exogenous shock to the Eurozone will come in June. At this time, America will open up a new Trans-Atlantic trade war front with the EU; in addition to its Trans-Pacific fronts with China, Japan and respective ASEAN trade partners. Ross signaled that German cars and tariffs thereon will be the first order of battle to commence in June. Germany and its exports have also been viewed in America as the key strategic fault line in the Eurozone that can be exploited.

Mr. Market will now anticipate and discount a deterioration in German economic growth between now and June. The ECB's current extend and pretend (that the normalization is still on) has therefore been completely outflanked by the American auto maneuver already. Compared to this tactical defeat, a post-mortem on Draghi's failure is academic and redundant. The ECB needs to fill his chair ASAP and deal with the deterioration in economic conditions.

The EU needs to fill its leadership chairs and get the smaller nations aligned with the French and the Germans.

The Germans need to decide if they are global citizens or Europeans. It's funny how modern European history always comes down to a decision and things made in Germany.

The great German quantum-mechanic Werner Heisenberg would be completely at home with Germany's past and present happily co-existing in time space; along with each other and Schrodinger's dead cat bouncing in the economic data. That this is happening in a time of trade wars and uncertainty would no doubt be even more reassuring to him.

Unfortunately, the Eurozone and the global economy are macro-physical constructs and not sub-atomic quantum particles. All the different states cannot simultaneously exist together. There must be order and governance. They are also governed by human nature and emotions which are irrational. Heisenberg would therefore be less than happy with today's global-macro picture.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.