Independence is dead and there is a feared terrace legend doing economic match day punditry for the ECB. The Eurozone saga has clearly moved from the sublime to the ridiculous. Time for a holiday, before the backstabbing in Brussels and Frankfurt seriously kicks off!
The decision to select Christine Lagarde, as Mario Draghi’s successor, symbolizes just how desperate the situation in the Eurozone has become. It also shows that the ECB can drop the pretense of being independent. The appointment is political and she will be a politician rather than a central banker. ECB Vice President Luis de Guindos is an ex Spanish politician. Lagarde’s nomination makes it a clean political sweep at the top of the ECB.
ECB Monetary policy is now everywhere a political phenomenon in every sense of the word. The ECB’s credible commitment to independence is truly dead. The swift rally in gold prices, that greeted the news of Lagarde’s nomination, confirmed what Mr Market thinks about political central bankers.
(Source and caption, the Author)
The symmetry of the appointment of a German lady, as the new leader of the EU, confirms the essentially political nature of the economic decision making process in the Eurozone going forwards. These appointments also confirm that France and Germany are essentially running the Eurozone. They appear to be doing this through forced compromise however, rather than as team-mates.
(Source: The Independent)
This is a bad sign for the smaller Eurozone nations, who are now essentially pawns in the bigger Franco-German game. Far from being united, the Eurozone is actually split along Franco-German lines. This split will be exploited by those within and outside the Eurozone who have their own agendas.
The smaller nations fully understand that they have been subsumed. The question now is what they will do about it. In the past, they have been easily bought off, with a combination of fiscal laxity and monetary largess. No doubt they will be offered more of the same. No doubt they will be easily bought. Italy will be the litmus test.
(Source: Bloomberg, caption by the Author)
Things are even worse, since France seems to believe that it is in total control of the situation. This cognitive bias has reinforced the self-confidence confirming bias of the French; so that they have become arrogant enough to think that they can dictate terms to all.
Such arrogance was evinced in the racist stereotyping, of the national psyches within the Eurozone, indulged in by French Finance Minister Bruno Le Maire. His behavior makes the levity indulged in by this author look polite in comparison! It marks an embrace of the new Populist zeitgeist and lexicon of the Eurozone; as the political classes sink to a new low of behavior and morality. The French finance ministry then followed up on its racial epithets with a threat, that EU budget rules must be enforced before they can be changed, just to inflame matters further.
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One can imagine Demosthenes face-in-hand, ruefully thinking along the same lines as Le Maire, during his epic struggles against foreign tyrants; as he sought to order the diverse Greek city states into the first European Republic. Evidently, Homo Europeanus hasn’t changed much over the millennia; nor has his burning enthusiasm to bring order and governance to the disorderly and ungovernable. The tyrants are still out there too, increasingly so today.
(Source: cliffkulesnotes.com, caption and editing by the Author)
More interesting is the fact that the perverse European belief, that this can all be somehow kept afloat by debasing the unit of currency of the day, has charmingly endured over the millennia also. Despite the compounding historic evidence that this has never worked, the enthusiasm seems to be stronger than ever today. This may be just proof that currency debasement is the easiest thing to do, when faced with difficult political and economic choices however. Men and women will always seek the easiest solution at the time, despite the cost to those who follow later.
What also stands out today is that there are always an elite few who accumulate more of the debased currency unit than the majority. This is then actually viewed from the reference point of the majority as deflation, since they have no debased currency. The political leaders of the day then debase the currency further, to make the majority feel richer momentarily. Ultimately their riches are swiftly transferred to the elite few through commerce and the cycle repeats itself.
The Eurozone is in deflation of the majority price-discovery mode once again.
The tiny republic of Cyprus is emblematic of the elite Franco-German objective to save themselves at the expense of the majority of their smaller brothers and sisters. It is also emblematic of the great currency debasement and accumulation game that has been repeating over the millennia.
Cyprus has become the first Eurozone nation to enter the deflation zone on an annual basis. The reforms of Solon inflicted by Lagarde on Greece and Cyprus, whilst she was at the IMF, have tilted the local inflation backdrop to the downside. Now she will get to reap what she has sown over at the ECB.
Cyprus has been heading inexorably in this direction since the autumn of 2018, rather like the guidance of “Rehnfeld” as we shall see later. This also illustrates the inertia of the ECB to embrace reality over time until now, whilst the Eurozone’s Big Two divide and conquer. Their victory is a stalemate for themselves and a defeat for the smaller nations; that now needs to be addressed financially.
(Source: investing.com, caption by the Author)
There is also a sense of a Carthaginian peace, being handed to the nations to the East of Berlin, as the EU hardens its borders and resistance to Russian interference. The terms seem to punish those who have shown affinity with Russia, by denying them a voice in Brussels. This may curb current Russian influence in policy making, but the cost will be loss of EU influence in the nations being punished. With no representation in the higher echelons of EU policy making, after the Franco-German deal, these nations will be even more open to Russian subversion going forward.
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Outside of the Eurozone, there is also global symmetry with the suggestion that Mark Carney should replace Lagarde at the IMF. All this means that the Globalists are simply reshuffling the personnel but maintaining the same message and strategies. Said message and strategies have alienated and disenfranchised those who have not got financial asset exposure to them. Far from subduing Populism, the new global wave of appointments is more likely to invigorate the Populists. President Trump has certainly been reinvigorated.
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This Franco-German split will soon become a huge problem for Lagarde, at the Eurozone level, since she is French. She may try and act German, but there will always be that nagging doubt that she is following a strictly French political agenda.
Lagarde’s embrace of the smaller nations will be similarly viewed with suspicion. Her track record on objectivity at the IMF was mixed. Whilst smiling sweetly and allegedly supporting growth policies, this tactic concealed a very firm hand when it came to the fiscal probity of those being sweetly smiled at.
The Germans have notified Lagarde that they will be scrutinizing her actions very carefully. The CDU party leader Annegret Kramp-Karrenbauer immediately informed Lagarde; that her party expects nothing short of a switch, away from Draghi’s “do whatever it takes” approach, to a strict adherence to independence and the ECB’s 2% inflation target mandate. Since inflation is way below 2%, this still gives Lagarde a great degree of latitude however.
(Source: Amazon, caption by the Author)
Ironically, despite their pretentious Sturm un Drang to hold the ECB to its single mandate, it may be the Germans who twist Draghi’s arm “to do whatever it takes again”, well before Lagarde hits the ground running. Cognizant of this deterioration, but not wishing to appear alarmist, the Bundesbank recently slashed its growth and inflation forecasts for this year. The German central bank is now running to keep pace with the deterioration, yet continues to lag the reality.
Germany is rapidly becoming the Sick Man of Europe, having once been poised to be the healthy man who consolidated his neighbors.
Germany is currently going through a period of what is un-affectionately called “Kurzarbeit”. This is known as a “short-time” in the Anglo Saxon vernacular. It is used to idle workers, rather than lay them off, when things are slow. Now put this into the context of massive immigrant inflows, to do hypothecated work that has never come; and one has a recipe for the political suicide of Globalist elite in Germany.
The ratings agencies are expecting a spike in Germany Inc defaults, for the first time in a decade. This would then make Germany Inc a consolidatee , rather than a consolidator, as the Eurozone lurches towards deeper integration via consolidation. Germany’s best laid plans for its economy to swallow its neighbors are in shreds. The predator turned prey will raise alarms and also protectionist tendencies at home. These domestic protectionist tendencies will then beget reciprocal protectionist feedback abroad.
(Source: Bloomberg, caption and editing by the Author)
France is in no position to mock Germany’s economic affliction. President Macron has sent a twenty feet tall rooster on the road, to persuade young French people to work in a manufacturing sector that is in contraction. The size of the rooster reflects the size of Macron’s credibility gap with the scale of the problem.
Just when it looked like things couldn’t get any worse, the European Banking Authority (EBA) has sneaked in a little bombshell all of its own. Last year all Eurozone banks passed their stress tests with flying colors. The EBA now cheerily admits that this is because it deliberately lowered the bar. The bar was thus lowered when economic conditions were stronger than they are now.
The EBA is therefore telling us all that the Eurozone banks are in a bad place, in fact even worse than previously imagined. This means that any future monetary policy easing, which takes interest rates even more NIRP, must be accompanied by mitigating measures for the banks.
This also means that the banks are not in any way able, to sustain any economic stimulus on their own, without further ZIRP/NIRP-mitigated monetary policy easing from the ECB. The banking system is a headwind and the broken private credit creation process is currently running on fumes.
Against this depressing backdrop, Christine Lagarde suddenly appears as an outsider in the cozy fraternity of Eurozone central banking. Not exactly a recipe for success.
(Source:projectsyndicate, caption and editing by the Author)
The innate requirement to appear objective, in a role that is politically sensitive, will undermine Lagarde’s effectiveness in making monetary policy. Ultimately, it will alienate her from a significant portion of the Eurozone polity as well as her working colleagues. Commentators will be unable to resist commenting on whether she is acting French or German when she acts. Eventually this will lead to her downfall, in these acutely Populist times in which the Eurozone is living.
(Source: Bloomberg, caption and editing by the Author)
Mario Draghi will be overjoyed at the prospect of being replaced by Lagarde. His succession by “Rehnfeld” threatened to unleash an inquisition, masquerading as a policy framework review, which may have destroyed his legacy and reputation.
The graph of Cypriot inflation above, illustrates clearly the lengthening period on Draghi’s watch; over which the ECB was asleep at the wheel, promoting its own ideas of monetary policy normalization. Over this period, Draghi’s credibility gap was growing as the calls for a policy framework review grew louder.
The ECB’s failure to act would ultimately have found someone to blame and Draghi was at risk of being him. Now he has the chance to redeem himself before he disappears. The ECB under Lagarde will also follow his politically driven mantra to “do whatever it takes”. A nice obituary for Draghi now follows, rather than blame and ridicule, so that he will be placed in the Pantheon of Eurozone gods.
It no longer matters what other Governing Council members say. All that matters is how Lagarde initially sells the ECB’s new political mandate. Cleaning up the mess that the boys have made should be no problem for her, since this is essentially what she has been doing most of her career. She should have no trouble in selling another round of “do whatever it takes”. Her appointment is a tacit signal that the ECB is still going to “do whatever it takes” to hold the Eurozone together.
Lagarde’s first test will come in signalling how she is going to walk the fine line, between fiscal deficit discipline and monetary policy largess. This will be a particularly difficult circle to square. If the ECB “Disenfranchises” itself, from being involved in national debt restructuring, then it will be hypocrisy for Lagarde to opine on structural economic reform since it will effectively have no skin in the game.
The last report noted that the Executive Board would have the final say over whether the ECB can “Disenfranchise” itself, of voting rights on sovereign bonds it owns, in the event of defaults. This is viewed by Mario Draghi as the condition precedent that will allow the ECB to change its Capital Key rules, in order to boost its balance sheet further in the next round of QE.
“Disenfranchising” itself is seen by Draghi as a quick fix, for opening the door to changing the Capital Key rules on its debt purchases. By following this process, the ECB is actually opening itself up to the possibility of capital losses; and insolvency of its own in the event of default by a sovereign. The only solution is for it to print the money that its needs to cover the insolvency hole. This breaks the prime directive not to monetize deficits. Watching Lagarde sell this heresy, with all her political skill and doublespeak, will be interesting to watch. Watching Mr Market’s reaction will be even more interesting.
There is no way that Draghi would steal the thunder from the Rock Star Lagarde. “Disenfranchisement” and balance sheet expansion is her decision, since she will have to own it. If he goes for it now, it can only be with her blessing; since she will be inheriting the maelstrom that he is bequeathing.
Opining the Executive Board’s measured opinion, in response to Draghi’s new “Disenfranchise” initiative, Yves Mersch told a largely German audience the board’s view of the current baseline on monetary policy. This view was laid out in order for it to be dragged into the context of the new reality facing the Eurozone. What then followed was a dragging into context by various speakers.
Mersch’s anachronistic baseline was an adherence to the current QE commitment; with no sign of an expansion or a normalization until after the first half of 2020. This stance is in light of his view of the current balance of risks, which is clearly skewed to the downside. His largely German audience would therefore not be worried of an imminent expansion of QE. They have however been tipped off that it may come between now and H1/2020 as things get worse. The ECB has between now and June 2020 to nudge this baseline towards “Disenfranchisement” and further QE.
Following the prompt by Mersch, the ECB’s new Chief Economist Philip “Penny ”Lane hit the ground running. According to Lane, advanced forward guidance to move the ECB’s baseline into monetary the expansion zone is the tool that will be deployed next.
Governing Council members Klaas Knot and Pablo Hernandez de Cos then framed this baseline, with the prelude to advanced forward guidance, to signal that it is about to shift Dovishly. According to Knot it is “indisputable” that inflation is too low. For Governing Council member Pablo Hernandez de Cos, it is “far” from target.
Governing Council member Francois Villeroy de Galhau used the old size is everything analogy to show just how far the baseline will be nudged. Apparently the ECB has not run out of ammunition; and in fact has considerable amounts available to be deployed as and when necessary.
ECB Vice President Luis de Guindos struck up just the right tempo of cadence, in his prelude to advanced guidance, to suit the ECB’s transition of leadership in this time of crisis. He simply stated that the balance of risks is now clearly tilted to the downside. This gives Mario Draghi the flexibility to act, even before Lagarde is installed. Clearly Lagarde will indicate to Draghi that she is cool with his pre-emption. She may also affirm this agreement in the public domain with advanced guidance of her own during her confirmation hearings.
Presumably the Draghi-Lagarde call has already been made, if the behavior and guidance of “Rehnfeld”is any guide. Picking up where de Guindos tailed off, “Rehnfeld” opined that further monetary stimulus is now required. “Rehnfeld” has just moved the baseline back into easing mode. This view was then underlined by his Governing Council colleague Ignazio Visco.
Draghi therefore has the green light to move any time that he feels ready.
(Source: Bloomberg, caption and editing by the Author)
“Rhenfeld’s” move has been a long time gestating. His impregnation began last June, on the ECB’s 20th anniversary which it had little to celebrate. The Eurozone’s current headwinds roughly began to blow from there, as the Trump inspired global stimulus wore off on the emergence of his protectionist agenda.
(Source: The Author)
“Rhenfeld’s” acceleration picked up in February this year, when the purported temporary impacts of the global headwinds started to be accepted as structurally permanent. Up until then he and his colleagues had “procrastinated”,that the slowdown was predictable and would be temporary in nature. He now opines that the slowdown is permanent and needs action, just in order for the ECB to meet its current mandate. The EU has now wheeled in the Rock Star from the IMF to deliver.
The chronology of “Rhenfeld’s” delayed response, clearly shows that the ECB has been at least a year behind the global curve. During this time, it has persisted with the guidance and charade that it will be normalizing monetary policy in the future. This stance is in effect a further tightening of monetary policy by guidance versus weakening real-time events. The monetary policy reaction going forward must therefore be of a greater magnitude and duration, than the last move to ease when the Fed inflicted a Taper Tantrum on the global economy.
Almost immediately after the ECB’s baseline got nudged, the trade situation deteriorated to a point at which the new stimulus is required. No sooner had President Trump celebrated, his alleged trade win at G20, then he immediately turned his trade guns on the EU. The US will now levy more tariffs on the EU in reciprocal action for the EU’s attack on Boeing and US Tech. President Trump will also go after the ECB as a currency manipulator.
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There is one serious inert obstacle in the way of the ECB’s advancing baseline. This is the obstacle of trade negotiations with America. President Trump is apoplectic to say the least, about all the easing guidance coming from the ECB. He views it as a deliberate unilateral attempt to weaken the Euro and well he might.
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Cognizant of this trade obstacle, Villeroy de Galhau attempted not to advance further to make contact with it. As the epiphany of Lagarde and what she may mean for monetary policy became accepted, he deftly tried to frame this vision in less antagonistic terms for Americans. Speaking to CNBC, he noted that there is growth on both sides of the Atlantic and rising wages in the Eurozone.
Suddenly, someone in the ECB has embraced the Neo-Classical success of rising real wages that has been framed as failure recently. In truth however, Villeroy only did this for his American audience in order not to provoke them further. He thus hopes to soften America’s attitude to trade negotiations. If this does not work, then the ECB’s Dovish baseline will crash through this trade obstacle, in what President Trump will call the first shot in a currency war.
Benoit Coeure then summarized for the Executive Board; thereby showing how the original baseline had been nudged from Mersch’s starting point to the current day. Coeure now sees that his colleagues on the Governing Council have the latitude to ease again, if and when they believe that it is appropriate to do so. He also sees that lower inflation expectations have moved from being temporary to permanent. This gives the Governing Council its motive, along with the means that he has already provided. The opportunity is now their call.
Further opportunity was afforded by the timely release of the minutes of the last Governing Council meeting. The minutes show that, there was consensus acceptance that the balance of risks was tipping to the downside; and that falling inflation expectations were becoming a permanent feature.
Since Lagarde is uniquely qualified to deal with global issues, it would make sense for the ECB not to press on and leave it for to use her unique qualifications to try to schmooze America. If this is the case, Mario Draghi needs to be told to stand down soon. President Trump should also be notified of the incoming schmooze. He may have a lower opinion of Lagarde’s unique qualifications and hence her schmooze than Coeure however.
Lagarde may wish to kiss the Blarney Stone before schmoozing America. It looks like one of her newly promoted colleagues has practically ingested it already.
Scally Boy turned Chief Economist Philip “Penny” Lane showed himself to be quite the schmoozer, as he took to Twitter to signal that he is hip and cool with this social media guidance lingo. Since it was in fact a thinly veiled market perception framing exercise, questions that conformed to the desired guidance objective were cherry picked and answered with cringe-worthy aplomb.
(Source: Twitter, caption and Tweet by the Author)
Under a barrage of questions, Lane chose to answer the easy ones only and avoid the hard technical ones.
(Source: Twitter, caption by the Author)
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Enough said! It was a game of one half. Having come through the first 45 minutes unscathed, Lane took an early bath. The boy done well!
Apparently this is what Lane really meant to say ….
(Source: Bloomberg, caption by the Author)
According to Lane, the ECB has the tools available to tackle the next downturn. Having ducked the issue of Safe Bonds, which are one said tool, he was also vague about the other tool. Said other tool is the Capital Key weighting that currently limits ECB purchases of peripheral debt. Amusingly, the current Capital Key has a big limit for German bonds. The Germans shouldn’t be so smug about it though. If the German economy keeps tanking, this limit will soon get busted.
Lane would have us believe, that the ECB has the intention and capability to either deploy the Safe Bonds solution or the new Capital Key weighting solution. In fact, it does have the intention but not the capability. Lane’s little Tweet-fest was long on generalization and short on detail. Detailed questions, which would have spoiled the show, were avoided.
Safe Bonds must be legislated into existence by the EU nations. Changing the Capital Key involves the legal systems of each Eurozone nation accepting the dubious precedent that the ECB can “Disenfranchise” itself of voting rights on the bonds that it owns. These are big things to speculate about, even for a smug Liverpool Fan whose team have just won the European Champions League. Assuming that Lane has these options up his sleeve, he still requires legislators and lawyers to allow him to use them. This will take time, although a crisis will speed things up. Fortunately, he has one to hand.
If the ECB gets away with “Disenfranchising” itself , in order to enable indiscriminate further QE buying, the urgency for Safe Bonds is lessened. Safe Bonds are in effect a pooled way of avoiding the “Disenfranchising” option. This still leaves the ECB reliant upon external agents to enable it to use either solution though.
It’s now a matter of urgency and time. “Disenfranchising” is the nuclear option, in the event that the ECB needs to move before Lane has schmoozed his Safe Bonds through the EU voting process.
The ECB has however engineered flexibility in the face of extreme adversity. It now has at least two options on the table. The boys’ done well, but this is a game of two halves.
The second half has been neatly set up by the EU itself. It has now cut its growth forecast for 2020. Lagarde will be in position by then, but this forecast also gives Draghi time and space to come out and play now before he is substituted for her.
(Source: Amazon, caption and editing by the Author)
Much attention has been directed in trying to anticipate how Lagarde will act. Some have over-emphasized the role of the terrace hard-man Lane in her plans. These optimists will have been underwhelmed by his dull football analogies and references of late.
(Source: Bloomberg, caption by the Author)
Those looking for the edge, should visit what Lagarde’s former employer is saying. Lagarde is no economist and she clearly cannot rely on the “Annie Road” Governor either. Someone or somebody needs to give her a script. Fortunately there is one to hand.
(Source: Bloomberg, caption by the Author)
The IMF has however been preparing for the next Eurozone crisis for some time. It was therefore no surprise to see the institution hand Lagarde her to-do list, from its own perspective, recently in the public domain.
The to-do list sees limited scope for rate cuts at this point in time. This is code for saying that the Eurozone banking sector can’t handle it. This leaves QE as the policy option of choice. The IMF also says that those nations with fiscal room should use it. Evidently deficits don’t matter, as Lagarde’s old friend Dick Cheney used to say, when they are counter-cyclically ballooning in order to respond to an economic shock.
Said ballooning deficits also need to find a home on central bank balance sheets, so that interest rates don’t spike and choke off economic growth. This latter observation also fits the enhanced role of QE envisaged in this article. The one obstacle, in the way of the IMF Solution, are the ECB’s current Capital Key limits. One should therefore expect Lagarde to use all her political skill and legal training to push for Capital Key change and/or “Safe Bonds”. In this case, the “Scally Boy” will need to be match-fit.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.