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Not Your Eurozone Father’s Or Even His Father’s Trade War, But Still War Nonetheless


The current "decoupling" trade war is uniquely different from previous coupled ones.

The ECB fudges financial stability as it prioritises monetary inflation.

The deteriorating external economic environment is driving the ECB’s priorities.

The banking sector is way down the ECB’s list of priorities.

The Franco-German marriage of convenience has grounds for divorce.

(Source: ECB, caption by the Author based on the original by Bruce Lee)

As President Trump points the finger of blame at the Eurozone, in the new currency war, the ECB is pointing back at him with data. What the ECB has noted is a great decoupling. Global trade collapses, yet global GDP has yet to follow suit. It well may not, if global central banks and domestic fiscal policy make up the shortfall in aggregate demand with easy money. This trade war is therefore not a repeat of history’s global trade wars. Those who follow history assiduously and place bets accordingly, that would have worked out historically, may be in for a big surprise.

The global economic system is breaking down, politically created valves and choke-points of nationalist rhetoric and demagoguery are replacing it. This is not the end of life as we know it, it is simply a change of the way that things are done. As always, things are done and enabled the best on a tide of liquidity. As always, the central banks are obliging and enabling with the enabling tide. The louder the nationalist rhetoric and the uglier the demagogue, then the greater the central bank stimulus by default.

Demagogues come and go, especially in developed nations with fixed political election cycles, yet central banks have survived the test of time one way or another. They will survive as long as money and credit are the enablers of economic and political fortune. Central banks are the great appeasers of demagogues and angry mobs. They also remedially fix the problems of their appeasement when the unintended consequences get out of control. As demagogues come and go, so the central bank presidents and chairmen follow the same vicissitudes of the economic and politically dialectic of the day.

(Source and caption by the Author)

The central banks are the saviours. They also have the ability to become the villains, if and when they give us all too much of what we asked for. As noted, in the series of reports on US monetary policy, the Fed has resorted to its secret asset price targeting mandate; in order to manage the monetary inflation that it is creating. It is supposedly targeting price inflation, yet it is actually creating monetary inflation. Thus far, the monetary inflation has not transmuted into price inflation. The absence of price inflation, is emboldening the Fed to create more monetary inflation.

The ECB is also experimenting in the same way as the Fed. After the ECB Governing Council signalled that easy and easier monetary policy is to be expected, from now through 2020, it has become instructive to observe how the central bank will deal with the monetary inflation that this creates. The ECB addresses the dark side of monetary inflation risk as financial stability policy.

(Source and caption by the Author)

The situation is becoming unstable, because the ECB is proceeding on several broad fronts in order to create more monetary inflation. It is currently constrained by financial stability rules and regulations. These rules are set to prevent the very financial instability that the ECB is proposing to create. The first constraint, is the prime directive not to monetise fiscal deficits. The Capital Key rules on further sovereign debt purchases is the derivative of this prime directive.

The ECB is now trying to bend the prime directive, by adopting inflation targeting as its replacement. It is also trying to bend and/or change the Capital Key rules. In addition, it is taking legal opinion on how to “disenfranchise” itself in state insolvency situations; thereby allowing it to buy said state debt with unlimited abandon going forward.

All of the ECB’s initiatives have dangerous foreseen and unforeseen consequences. One would therefore expect it to at least attempt some foresight. It has .….. sort of!

The European Systemic Risk Board’s (ESRB) annual report, was the first post-Governing Council meeting draft of Eurozone central bankers’ attempts at financial stability foresight. It was written with a worryingly huge disclaimer however.

(Source: ESRB, caption by the Author)

The ESRB is the financial stability tail, that is wagged by the monetary policy dog of the ECB. The ECB is the largest stakeholder in the ESRB. Thus conflicted, the ESRB is incapable of being objective about the risks that its largest stakeholder is both mitigating and creating. Anything the ESRB says should therefore be taken with a big pinch of salt.

At the top, is the global headline trade war driven growth risk that begets the monetary policy response.

Next down, is the weakness in the banking sector; derived from the trade headwind and the ECB’s ZIRP/NIRP monetary policy response.

Following on, is the high level of public and private debt that the ECB is addressing with ZIRP/NIRP and its own balance sheet.

Lastly comes the shadow banking sector, which grows out of the hunt for yield in the response to the new ZIRP/NIRP world.

(Source: ESRB, caption by the Author)

The ESRB annual report can be conflated with its latest dashboard publication. The dashboard shows that whilst elevated, today’s financial risk is not comparable with the levels seen before the GFC. No doubt the ECB would and will argue that this is a testament to the massive levels of QE in the system. It will then go on to opine that, given the current growing global economic risks, monetary policy should be expanded further. This will be presented as an insurance policy, against current and future elevating financial risk, rather than as a new financial crisis response per se.

The ESRB and the ECB will not opine that monetary policy expansion which incurs deeper NIRP will significantly raise the level of financial risk. To do so, would be to undermine and even negate the carefully scripted case for monetary policy expansion currently being written by Draghi, “Rehnfeld” and Lagarde et al.

(Source: ESRB, caption by the Author)

The ESRB’s annual report and dashboard should be framed, by Mario Draghi’s overlaid macroprudential disclaimer that he issued in April this year. This disclaimer clearly shows that Draghi has been considering the next monetary policy expansion for some time along with its consequences. Evidently, he has decided to relegate the macrostability consequences of any such monetary policy expansion to his posterity and Lagarde’s inherited legacy.

Simply stated, Draghi denies any responsibility for macrostability, by arguing that the understanding of it is currently an inconclusive work in progress. This has got to be one of the Eurozone’s great moments of understatement leading to one of its greatest unintended consequences.

The takeaway from the ECB sock-puppet, known as the ESRB, is that financial stability is way down the list of the central bank’s priorities; hence it is happy to risk making it worse with further QE and ZIRP/NIRP.

This financial stability report and accompanying materials are just the ECB’s way of saying Keep Calm and Don’t Panic. We can apparently all rest easy, that an unsustainable asset bubble is not being created. We should do this because the ESRB i.e. his master’s voice the ECB, is telling us that counter-cyclical buffers are being raised as a precaution. The ESRB hasn’t however explained; how an admittedly weak banking sector can come up with said effective capital buffers against NIRP, especially in this rapidly slowing economic environment.

Mario Draghi has been forgiven on numerous occasions, for appearing to learn through experience in the brave new Eurozone post-GFC. On this occasion, his credibility is stretched beyond its limit; because he is literally just making things up to ex ante to fit his world view. He is once again “doing whatever it takes” and good luck to him. This is why he is paid the Big-Euros!

Mario Draghi has been forgiven on numerous occasions, for appearing to learn through experience in the brave new Eurozone post-GFC. On this occasion, his credibility is stretched beyond its limit; because he is literally just making things up to ex ante to fit his world view. He is once again “doing whatever it takes” and good luck to him. This is why he is paid the Big-Euros!

Criticism of Draghi should be tempered by an observation of the inability of Fed Chairman Powell to show the same dedication to “doing whatever it takes” at whatever cost. Powell has simply defaulted to a set of ex post rules of thumb, from a bygone era, which have so far proved to be anachronisms.

It is ironic to observe that Draghi’s foresight is now directly driving the Fed’s remedial action to it!

(Source: ECB, caption by the Author)

What is at the top of the ECB’s priority list was then communicated in its own latest bulletin. Whilst acknowledging some innate economic strength within the Eurozone, the ECB signalled that it is the global headwinds that are catching its attention; and thereby driving monetary policy decision making. This bulletin can thus be viewed as a prelude to and justification of further monetary policy expansion.

The de-prioritising of the Eurozone banking sector by the ECB is nothing new. This has been ongoing since the ECB first embraced unconventional monetary policy. The ECB is now prepared to sacrifice the banking sector even further. It is expected however to keep the banks on life support with a mixture of NIRP mitigating tiered interest rate measures.

(Source: ECB, caption by the Author)

The ECB recently took the pulse of the banking patient and published its findings in a working paper. The paper concluded that Eurozone banking productivity halved between 2006 and 2017. This begs the question of the utility and purpose of having Eurozone banks going forward, if and when the ECB presses ahead with more unconventional monetary policy stimulus.

Clearly there is a case being made for banking consolidation here. The consolidated unproductive whole would then serve as the effective bad bank, where all the problem loans are held and worked through. The Eurozone is in desperate need of a source of new private capital however. Clearly, the consolidated whole is in a stronger position to lend. What is the point of lending though, in the world of NIRP, especially when the ECB is mitigating the legacy lending book? It would seem that in his haste to ease further, Mario Draghi has not considered what kind of banking sector is being created, versus what is needed in the future. Christine Lagarde may be none the wiser also.

Austrian School traditionalist and Governing Council member Ewald Nowotny is struggling, to come to terms with the new normal that was heralded at the last meeting. His guidance is therefore an amusing combination, of his traditional longing for a normalisation of monetary policy, overlaid with the prospect of further monetary policy easing. He now sees monetary policy normalisation in the “long term”, but with interest rates at lower levels than historical averages. This is about as Dovish as he can get, but it is relatively extreme Dovishness versus his own historic average.

Nowotny’s discomfort and dissent won’t last for much longer however, as his term expires shortly. He is thus left to play a cameo role with valedictorian speeches warning of the horrors of further QE. To all intents and purposes, these fall on deaf ears and his practical contribution to the monetary policy debate is effectively over.

A previous report noted the Franco-German axis driving the Eurozone. It was also noted that this partnership is a marriage of convenience, rather than a shared vision for the future of the Eurozone. Germany has its Far-Right demons, whilst France has its Yellow Jackets. Both demons represent a strategic threat to each nation and hence the marriage of convenience.

(Source: Bloomberg, caption by the Author)

Germany has prospered from a single currency that has made its exports competitive. In the new global currency wars this is now challenged. Germany has gone into to this challenge with a balanced budget however, which at least gives it some fiscal room to respond. A weaker Euro helps, but it is not as crucial for Germany as it is for France.

(Source: Bloomberg, caption by the Author)

The German dogmatic fixation with “Black Zero” fiscal policy even frames its commitment to climate change targets. Germany aims to be carbon neutral, through capping CO2 emissions whilst reducing taxes on clean energy. The overall framework will also have to be fiscally neutral from a budget perspective.

(Source: Bloomberg, caption by Sonny Curtis)

The German fiscally neutral dogma is not simply psychological it is also legal. It is Constitutionally illegal for the German government to take the plunge into the deficit stimulus that Eurozone nations are actively contemplating. This latter detail raises the barrier to German fiscal expansion significantly. It also raises the threat of German legal challenges to what the ECB is about to do next with unconventional monetary policy. More importantly, it legally challenges the very existence of the current German government. By extension therefore, German continued participation in the Eurozone and EU are legally challenged.

(Source: financemarketnews, caption by the Author)

Skilled German orators, like former Constitutional Court Judge Paul Kirchoff, are opining with some skill that the ECB is in effect an organ of Eurozone appropriation. Said appropriation is framed as misappropriation from law abiding German taxpayers.

(Source: literaturhandbuch, caption by the Author)

The German Constitution is set up to apprehend two thieves. One is inflation and the other is political appropriation. The Eurozone’s Shadow Constitution is now legislating in favour of these two thieves. Germany and the Eurozone are therefore legal adversaries. When the German’s were stacking up export surpluses they didn’t care about this legal distinction. Now that the chips are down, they have suddenly re-discovered their legal and moral compasses. This situation is now untenable.

If Germany cannot amend its constitution, it may be forced to leave the Eurozone of the future if fiscal stimulus and unconventional monetary policy are expanded further.

(Source: blogavira, caption by the Author)

Germany’s survival strategy of aiming to create surpluses has a global dimension. This was also highlighted recently in its trade data. Whilst exports collapsed, the Germans were still able to eke out a current account surplus. Germany is clearly inciting reciprocal trade barrier actions, especially from America. Indeed, Germany will be viewed as a kind of reverse Trojan Horse, hiding inside the EU’s trading system. From this strategic vantage point, Germany is able to build intra-Eurozone surpluses and global ones.

EU global surpluses are thus in effect German ones. Its Eurozone neighbours will say that, if Germany wishes to get the trade benefits of being a Eurozone member, it must reciprocate. Such reciprocation will demand a German fiscal stimulus and fiscal burden risk-sharing with its Eurozone neighbours. In return, the Germans will be offered the big carrot of a weaker Euro.

Der Spiegel newspaper recently tested the public’s tolerance, of a deficit-financed fiscal stimulus. Mr Market even obliged by weakening the Euro and nudging German bond yields higher. If the German public can be nudged into accepting fiscal deficits, it is possible that in time they can be nudged towards accepting Eurozone deficit financed stimulus also. Their reaction remains to be seen.

(Source: Bloomberg, caption by the Author)

Germany is now framed as the new Sick Man of Europe from an economic and political perspective. Its sick economy is portrayed as in desperate need of fiscal stimulus, which will then somehow translate into an economic stimulus for the Eurozone in general.

Conversely, Germany’s unwillingness to respond with fiscal alacrity is then framed as the catalyst for radical monetary policy easing by the ECB. Commentators want their fiscal cake served with extra helpings of monetary policy cream. The commentators should be blessing Germany. Without it there would be no future economic stimulus of any kind. If Germany didn’t exist it would have to be created by them.

(Source: Bloomberg, caption by the Author)

France has been relatively passive, by comparison with Germany, as the respective political combatants urbanely called a truce so that they could enjoy their summer holidays. As the holiday season winds down, the fault lines will reappear.

France has had the similar benefit as Germany from the single currency. It has however squandered this on fiscal profligacy. President Macron has belatedly tried to get it on fiscal parity with Germany. This move however encountered staunch Yellow Jacket resistance, which effectively stalled it at best and has even U-turned it in some cases. He now desperately needs a weaker Euro to keep him afloat.

From a debt-to-GDP perspective, France is the weak partner in the Franco-German marriage; even though Germany garners the headlines for being the weak manufacturing partner. Both need a weaker Euro, but for slightly different reasons. Germany needs it to stimulate its exports. France needs it to inflate its way out of its crippling debts. The two countries are therefore married for different reasons. They are also not averse to leveraging over each-other’s weaknesses. Over-zealously leveraging too much, threatens to bring the whole house of cards down.

A weaker Euro is a must-have for both. The inability to devalue the Euro, in the face of other nations who are doing the same, will put strains on this marriage. Germany will apply its fiscal surplus at home. France has no room for a fiscal stimulus of its own. It will then pressure Germany to weaken Eurozone fiscal rules or face an ugly divorce.

The German and hence by default Eurozone global trade surplus is a natural driver of Euro currency strength. With its surpluses, Germany can subsist with a strong Euro for a little while. Applying “Germany First” criteria, on how it spends its fiscal stimulus, will allow it to weather some of the global trade war storm.

A stronger Euro will allow France to finance its deficits and thereby keep the Yellow Jackets from the gates of the Elysee Palace. Both countries can therefore co-exist with a strong Euro, but life will remain difficult for their political leaders. The French leadership will find it the most difficult to survive, with a stronger Euro, if it continues to try and become German with fiscal reform.

(Source and editing by the Author)

A previous article noted that Mario Draghi had been given the green light, by Christine Lagarde, to steel her thunder through embarking on the next phase of monetary policy expansion before she takes office.

(Source: Bloomberg, caption by the Author)

“Rehnfeld” recently communicated that Draghi should avail himself of this opportunity in September. The next easing phase, initiated by Draghi and presided over by Lagarde, will in “Rehnfeld’s” view be a “very strong package”. The contents of the package will allegedly include both bond buying and interest rate cuts.

This will in effect be the “Shock and Awe” anticipated from Lagarde. It will shake the world and the global term structure of interest rates to even more negative levels.

(Source: FT; caption by the Author)

“Rehnfeld” even hinted that the ECB will indulge in QQE, with equity buying as this easing phase progresses. The American series of reports, that conflates with this series, has noted that central banks are under siege from “Masters of the Asset Class Universe”. These alleged “Masters” view central bank balance sheets as a threat that can be turned into a source of profit for the duration of the next global monetary policy easing phase. The fallacy of central bank equity buying was also exposed; as just being a catalyst for P/E expansion, rather than a real driver of capital investment per se.

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

“Rehnfeld’s” views on equity buying, appear to come straight from the lips of one of said “Masters”. Having failed to get the ECB presidency, “Rehnfeld” may be a lone gun for hire by the “Masters”. He is also allegedly in the running for Lagarde’s old job at the IMF. The fact that he recently chose to reveal the ECB’s purported next move, in the Wall Street Journal rather than a European publication, suggests that he has a global agenda.

(Source: The Author, caption by Theodore Roosevelt)

This American series also noted that the ECB is clearly driving Fed monetary policy decision making. The shadowy figure of “Rehnfeld” can thus be represented as an invisible FOMC member. Whatever awaits him, it is clear that the “Masters of the Asset Class Universe” have a human asset in him. He may not be the “Rock Star” Lagarde, who gets all the publicity, however his invisible hand and nondescript commentary have been more influential thus far.

Just because the next phase of QQE has been kicked-started already, it does not mean that Lagarde can just smile and continue to look good however. She has some real work to do, besides persuading the Northern European contingent of the Governing Council to back QQE.

(Source and caption by the Author)

Lagarde also has to ensure that the mechanism that will deliver QQE is in place. This mechanism depends on a combination of Capital Key limit changes and/or pooled Eurozone “Safe Bonds” for the ECB to buy. It will also involve getting inflation targeting adopted along with the legal precedent for the ECB to “disenfranchise” itself. Once again, getting the Northern Europeans to legislate for these critical enablers is going to exhaust all of her political skills.

(Source: Deutsche Bundesbank, caption by the Author)

The resistance to Lagarde from Germany is going to passive-aggressive at best and aggressively-partisan at worst. In anticipation, the Bundesbank is already erecting defensive countermeasures. The most recent obstacle is a publication, which finds that the minefield of unconventional monetary policy measures kills more friends than foes.

One would have expected a prostrate Germany Inc. to have helped Lagarde’s cause. German politicians are however more afraid of the German People than Germany Inc. The German People, as of yet, are more worried about paying for immigrants and perceived feckless Eurozone partners than bailing out Germany Inc.

The nuance of the economic threat to the German People needs to be re-framed and then amplified.

Lengthening German unemployment lines only translate into votes for the Far-Right at present. Political skill is required to turn them into votes for a fiscal deficit stimulus and deeper Eurozone integration. This political skill has abandoned Angela Merkel, at this critical point in Eurozone and German history. It is also lacking in all her would-be replacements. Failure to rekindle this spirit will present a threat to the Eurozone Project far more potent than Brexit. Britain has always played the balance of power game on the margins of the Eurozone. Germany has always played Core European games, throughout its history, out of geographical necessity. Now would not be a good time for it to go rogue again when it plays this game.

(Source: De Nederlandsche Bank, caption by the Author)

Core resistance from the Dutch is far more aggressive than from the Germans. The Dutch clearly have a fear, that the fiscally profligate from all nations within the Eurozone will undermine the whole bloc. A recent study by the Netherlands Central Bank, found that QE is not an “appropriate” response to “country specific” shocks. This aims and fires directly at the whole casus belli for further QQE. The Dutch evidently see the fiscal risk that even Germany presents, as its economy weakens and its fiscal deficit widens as a consequence, in addition to the traditional risks to be found in Southern Europe.

As she thinks about, how to expend her air miles and political capital, Lagarde should perhaps consider starting in Holland first and then swiftly moving on to Germany. She will end up everywhere and perhaps nowhere if she is not focused.

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.