(Source: Macmillandictionary, caption by the Author)
The global economy is currently in transition as the American presidency changes. This global phase of transition is also mirrored by a phase of transition within the ECB, as one of its founding-fathers steps down. The transition in the EU is also being accompanied by German transformation. These events should not be viewed in isolation. History is being made. It may also be repeating or just rhyming. The ECB’s Chief Economist has dubbed this phase Copperfastening. The guidance that goes with it is clearly defined in the dictionary.
With President Trump out of the way, yet not exactly out of the way, European fears of currency and trade wars with America have abated sufficiently enough to give policymakers confidence to escalate their attack on the Euro.
Recent ECB hints about potential negative growth in Q4/2020 were underlined by elected officials beginning in France and Germany. Some ECB speakers also re-visited the formerly taboo subject of foreign exchange rates and the allegedly strong Euro. It was almost as if President Trump had been a bad dream and things were returning to normal. By contrast, the COVID-19 situation is no dream and still remains a very real nightmare despite the good news on the vaccine front.
French Finance Minister Bruno Le Maire signaled that he will be cutting official growth forecasts in the near future. The Bank of France concurred, with the qualification that the next lockdown-induced slowdown will not be as bad as the first one. The French public isn’t having it, however, and is now convinced that the pandemic is being used as a cover for the removal of their constitutional freedom.
The Spanish contingent at the ECB has become more vociferous about monetary policy as the COVID-19 pandemic escalates. Both Bank of Spain Chief Economist Oscar Arce and Bank of Spain Governor Pablo Hernandez de Cos stepped up the deflation risk guidance and demands for further easing to address it.
(Source and caption by the Author)
ECB Executive Board member and general all-round good European Yves Mersch’s replacement Frank Elderson has been tested, by EU lawmakers, to see if he has the same right-stuff. This test has thrust him into the feverish debate over whether the ECB’s Pandemic Emergency Purchase Programme (PEPP) should remain temporary, or be allowed to drift into permanence through the proceeds reinvestment process previously outlined by Executive Board member Isabel Schnabel.
Apparently, Elderson is a chip off the old block and believes that the PEPP should remain temporary in nature. Unfortunately, this stock answer ducks the question as long as the pandemic remains prevalent, thereby, requiring the PEPP to continue. Indeed, it encourages the permanence of the program by creating the opportunity for the reinvestment that will make it so.
Capital Markets Union is an objective that ECB Governing Council member Klaas Knot has been advocating for strongly of late. Given that there is a heavy reliance on bank financing in the Eurozone, the current weak state of the banking system is an impediment to economic growth. Capital markets union would provide an alternative means of financing, that could put the Eurozone on a more competitive footing in the global capital markets. Knot’s longing for deeper and broader capital markets is an implicit acceptance of the economic headwind caused in the banking system from the ECB’s negative interest rate policy. It is, also, an acceptance that the banking system is struggling to maintain the transmission mechanism of monetary policy in the negative interest rate world. His concerns were evident in what followed from Christine Lagarde.
As the EU moves one step closer, to firing its unprecedented fiscal stimulus, Christine Lagarde has warned elected policymakers that this is not the beginning of the end of the COVID-19 pandemic. In her view, the negative impact of the COVID-19 crisis will be felt for some time to come. Some of the impacts will be more permanent, especially on employment. The Eurozone’s mature economy is one based on services, which have been particularly prone to the ravages of the crisis. These ravages will linger and there is a fear that they will become the new expected norm. Consequently, she expects fiscal policy to do most of the heavy lifting because it has a greater immediate impact on the real economy than monetary policy. Monetary policy will play a supporting role, with one slight tweak.
The transmission mechanism through the banking system must be preserved. Thus, Lagarde flagged that further interest rate cuts will be put on hold whilst the ECB focuses on a blended mix of emergency short-term pandemic stimulus and longer-term traditional quantitative easing.
(Source:ECB, caption by the Author)
Implicitly, Lagarde was also flagging that the ECB is increasingly concerned about the health of the Eurozone banking sector. This concern was also flagged separately by her staffers. The staffers estimate that the Eurozone reversal rate is circa -1%. Whilst this is some way off, what the estimate does is to set a numerical constraint on how much further interest rates can fall. Negative interest rates can, thus, be seen as a finite economic stimulus and, hence, the ECB must use them more sparingly.
As a result of its analysis, the ECB is now prioritizing the banking sector more highly than it has done before during the COVID-19 pandemic. The staffers have also suggested raising pro-cyclical capital buffers to deal with the stress from negative interest rates. Clearly, there was no appetite to do this, during the recovery from the original GFC, because COVID-19 and NIRP were not foreseen back then. This means that the banks, currently, have no buffers in place to deal with the current crisis. Attempts to trans-nationally consolidate them have, so far, met partisan resistance in the boardrooms and respective national parliaments involved. The situation is now so bad that the German banking regulator BaFin actually had to go on record to state that, whilst it is not anticipating any banking sector crisis in its territory, some German banks will fail.
(Source: ECB, caption by the Author)
ECB Vice President Luis de Guindos has tried his best to frame the ECB’s fears of another financial sector crisis as a call for lawmakers to legislate the steps, that will prevent one from occurring, into life. These steps are Banking Union and Capital Markets Union.
De Guindos cunningly explained the weakness in the banking sector as being mainly attributable to credit problems created by COVID-19, whilst conveniently omitting to admit that the ECB has compounded this problem with negative interest rate pressure on the banks. In his view, Banking Union is needed urgently to address the need for uniform standards to address problems associated with deposit insurance and insolvency resolution. Once again, he omitted that these mechanisms already exist at the national level, but nationalist protectionism has prevented their application. De Guindos was, however, crystal clear that Capital Markets Union is imperative to provide the scale of funding required for the COVID and post-COVID environment.
De Guindos then concluded his thesis, for the Eurozone financial sector, with some prescriptive suggestions. The banks should continue to address the overcapacity and weak profitability in the sector, through a mixture of consolidation and restructuring respectively. Whilst doing this, however, they should be careful to remain supportive of the monetary policy transmission mechanism. This transmission support can be done by them dipping into their capital buffers according to him. He mustn’t have read the report by his staffers which said that no such buffers have been created since the GFC.
Also unsaid, by De Guindos, was the obvious game of bluff that his prescriptive suggestions create. The first banks to dip into their buffers will be seen as being in trouble and their share prices will fall to reflect this. Consequently, they will become the consolidated rather than the consolidators. No bank executives would willingly put themselves into such a position just to make the ECB happy. They would much rather gamble that their own governments will bail them out. His ideas are, thus, great in practice but unrealistic in reality.
Of the Eurozone real economy, De Guindos’s personal baseline is for contraction in Q4 of this year. This leaves the way open for further fiscal stimulus, which is his most desirable outcome; and or further monetary policy easing if the fiscal stimulus does not appear in time or is viewed as insufficient if it does.
Governing Council member Francois Villeroy de Galhau has tried his best not to sound as alarmist, as some of his colleagues, about the specter of the new financial crisis haunting the Eurozone economy. He, therefore, limited himself to a perfunctory projection of credible commitment with the words that: "we (the ECB) must maintain favorable and predictable financing conditions."
Governing Council member Madis Muller is even more concerned about the banking sector’s monetary policy transmission mechanism than he is about the COVID-19 pandemic. Based on this prioritizing, Muller believes that the traditional long-term QE program known as the Targeted Long-Term Refinancing Operations (TLTRO’s) should command more of the monetary policy mix than the shorter-term Pandemic Emergency Purchase Programme (PEPP).
The ECB’s concern for the banking system also seems to be prevalent, right now, in a number of developed market central banks. These concerns recently received greater attention at the ECB’s own online equivalent of the Fed’s Jackson Hole colloquium which is usually held at Sintra.
The Reserve Bank of New Zealand recently disappointed, about going negative and, instead supported the by easing with a Funding For Lending Programme. The 20% annual growth in house prices has got the New Zealand government and the Reserve Bank worried and in conflict with each other.
The Bank of Japan also recently gave its regional banks a funding incentive to merge their operations.
The Bank of England Governor is also backsliding away from his initial enthusiasm for negative interest rates.
Standing back from all this, it is logical to suggest that there is a rising probability that COVID-19 has induced a global financial sector crisis environment. Central Bank dalliance with negative interest rates has, actually, elevated this probability. The demands for further fiscal stimulus by the respective central banks involved are, thus, well made. The global takeaway is that we are all in for some more fiscal stimulus before the central banks monetize it all away again with some or more negative interest rates. During this fiscal stimulus period, the banks will be induced and forced into deeper consolidation, and capital increases.
In effect, the ECB is currently trying to save the banks, at the expense of the real economy, whilst the fiscal authorities are being asked to save the real economy.
Since the interests of the banks strongly vitiate against the interests of indebted fiscal policymakers the two will clash, in the near future, when it’s time for more negative interest rates to monetize unsustainable fiscal deficits. The banks will find it harder to enlist the support of beleaguered Eurozone depositors now that COVID-19 has seized the narrative. A broader and deeper Eurozone capital markets union, as an alternative to the current bank transmission system, will erode the bargaining power of the bankers if and when it occurs. The writing is on the wall for the banks if they do not consolidate.
Fear of a financial crisis is, thus, prompting the ECB to support the banking sector whilst also supporting the sovereign bonds that the banks have on their balance sheets. A doom-loop linking a sovereign debt crisis, to the monetary policy transmission mechanism, through the banking sector is not a good idea when the Eurozone economy is entering its second lockdown.
In what appeared to be a humble act of contrition, Christine Lagarde finally admitted that it is the ECB’s full-time job to manage yield spreads. On this occasion, the mission is to crush them. This was not some simple mea culpa in relation to her original sin of denying responsibility for yield spreads.
(Source: GlobalCapital, caption by the Author)
Lagarde’s latest admission belies her real fears of a new financial crisis and a serious attempt to prevent it. Her description of the current situation clearly articulates the fear that the Eurozone has reached the point at which liquidity preference has now replaced the aggregate demand function that had been driving consumption. To overcome this tipping point, fiscal policy will be needed to compensate for the loss of private consumption and the ECB will have to sustain this with sustained liquidity provision.
(Source and caption by the Author)
This is the MMT Zone.
Executive Board member Isabel Schnabel doesn’t want to give anything away about the December Governing Council meeting, in advance, thereby avoiding any messy pre-commitment. Whilst avoiding specifics, her guidance clearly shows where she would like the focus of discussion to be and where she would like it not to be. Without saying why, thereby indicating her fears for the banking sector, she opined that there are good reasons why interest rates have not been cut further.
Schnabel’s guidance focussed on the size and pace of bond purchases, further signaling that the blend of bond-buying programs will be the tools deployed. Schnabel is also very clear that fiscal stimulus should be the principal force applied to a situation that is subtly different from, that back in March when everything was being thrown at the pandemic.
Schnabel’s opacity, about monetary policy specifics, contrasts with her clarity about financial stability risks and the seeds of a new financial crisis. Whilst the ECB has mitigated the impact of negative interest rates on the banking sector there remains a glaring chink in its protective armor that covers the financial sector. Schnabel recently identified this chink.
The Eurozone non-bank financial sector is a source of immense concern for Schnabel in terms of financial stability risk. She has noted a plethora of risks, in this sector, that were cruelly exposed at the onset of the COVID-19 pandemic. These risks include asset-liability mismatch liquidity risk, leverage, margin risk, counterparty risk linked systemic risk.
Schnabel also notes that the non-bank financial sector is growing much faster than the traditional banking sector. Whilst this is a welcome source of financing for the Eurozone economy it falls outside of the ECB’s governance and monetary policy channels. There is, thus, no monetary policy or financial stability framework in place to deal with it effectively.
Schnabel’s thesis is that if there is another financial crisis, it is likely to come from the non-bank financial sector. Clearly, she is angling for the ECB to be mandated governance and supervisory control of this sector.
Governing Council member Pablo Hernandez de Cos, is expanding the list of reasons why the ECB should ease again to include the foreign exchange value of the Euro against the US Dollar. Apparently, whilst Euro strength is not a reason to ease per se, in so far as it impedes exports and reduces imported inflation it is a significant deflationary headwind.
Governing Council member Ignazio Visco has added to the list of reasons not to end the stimulus rather than to ease further. The next easing is a formality, in any case, so Visco is keen to prolong this stimulus for as long as possible. His reasoning is that an insurance policy is needed to underwrite economic growth going forward. It sounds as though Visco would be susceptible to a Fed-style new monetary policy framework.
(Source: the Author)
The Eurozone’s first two Modern Monetary Theory (MMT) foster-children are behaving themselves these days and avoiding the Populist tantrums that have embarrassed Christine Lagarde early in her career at the ECB. Their compliance suggests that they have accepted their fate, as wards of the EU, in the hope that their politicians can still pretend that they have preserved their sovereignty. In practice, sovereignty has been sold for a substantial financial consideration.
Spain is making progress towards a fiscal budget for next year and Italy is even further ahead in this process. In return, for moving towards full fiscal and political integration into the EU, with alacrity, the Spanish government intends to reward itself with all of the hypothecated 140 billion Euros to be transferred from the central EU coffer. Ironically, the Conservative members of the Spanish coalition government are criticizing the Prime Minister, for allegedly using taxpayer funds to buy the support of the regions and the Left-wing coalition members. In practice, Prime Minister Sanchez is using the EU’s money to buy loyalty in return for ceding effective political control to Brussels.
Both Spanish and Italian budgets are predicated on the assumption of inward transfers and guarantees, from the joint EU budget, enabled at a rate of interest, that does not hurt the European banks any further, controlled by the ECB.
The Italians are the doyens of both living beyond their means and political negotiating. If they are to sell their political sovereignty to the EU, then they intend to extract the highest possible consideration for doing so. In addition, they intend that the Eurozone to which they are surrendering will become more Italian, rather than more German so that they can enjoy their hard-won consideration in perpetuity. It’s a bit like Germany’s experience with reparations after World War I, except in reverse, with Italy receiving the reparations for unconditional surrender.
Riccardo Fraccaro, Prime Minister Giuseppe Conte’s Consiglieri, has made the EU an offer it can’t refuse, in return for Italian sovereignty, as they like to say in the Old Country. The ECB must either cancel Italian pandemic debt or agree to keep it on its balance sheet at a negative rate of interest forever. Furthermore, any Green Debt issued by Italy should be exempt from Capital Key limits. The Italians smell Modern Monetary Theory (MMT) and intend to exploit it by getting old debts canceled or monetized; and calling all new debt Green, thereby, making it easier to finance.
The last time that the Italians attempted to shake down the EU and the ECB, they threatened to ask for their gold back. Such a transfer would be an implicit return of sovereignty back to Italy. Apparently, now, they don’t want either their gold or their sovereignty back because they see a bigger prize.
The nuanced reaction, to the Italian gambit, from ECB Governing Council member Francois Villeroy de Galhau, was interesting, to say the least. He rejected the notion of debt cancellation, outright, as illegal. He was noticeably less clear about the ECB retaining Italian debt on its balance sheet in perpetuity. Evidently, the latter strategy plays into Christine Lagarde’s ideas for Modern Monetary Theory (MMT). It also crushes Italian bond yields and simultaneously mitigates the doom-loop to the monetary policy transmission mechanism through the Italian banking sector.
French Socialists also want French debts canceled as do many others throughout the Eurozone. The debt cancellation/moratorium/monetization issue is gaining political traction. Clearly, there is wiggle-room and potential political consensus to be formed on the ECB’s balance sheet as a permanent alternative to debt cancellation.
Based on the latest guidance, from Governing Council member Mario Centeno, there is a clear risk of Portugal becoming the third little PIG of the fostered Eurozone problem children. Centeno opined that the fiscal stimulus, in his country, must be directed towards growth and productivity-enhancing investments. These targets, allegedly, will have growth multiplier effects that will reduce the aggregate level of fiscal stimulus needed in a country that is already heavily indebted.
(Source: ECB, caption by the Author)
Based on the aggressive back and forth, in an interview between ECB Chief Economist Philip Lane and a Portuguese reporter, the feeling that the country is already a problem child is palpable in Portugal. If the ECB bought one Euro’s worth of Portuguese debt for each time Lane used the words “So to be ….”, in the interview, Portuguese yields would be more negative than German Bunds. The interview was hysterical.
Lane was put on the spot about whether he thought Portugal was an indebted basket case, with a failed baking system, that was in need of massive ECB bond-buying to save it. All that he could reply, after prefacing his response with “So”, was that the ECB only looks at the Eurozone on aggregate and does not comment on nation specifics. The interviewer was clearly unimpressed and exasperated by Lane’s “So-Stonewalling” and “So” gave up. Lane was, however, able to deliver some good news along with his unconstrained “So’s”.
In contrast to Schnabel, Philip Lane was happy to telegraph the Governing Council’s intentions and capabilities to ease again. He was, however, economical with the exact details of the size and component programs of the next ease, thereby, implying that nothing specific has yet been agreed upon and that no current consensus exists.
Presumably, under the advice of his media team, Lane dropped the “So” for his next interview. Evidently, he’d had a bit of coaching during the interim and, so, was easily able to dodge the bullets that his French interviewers fired at him. He was, thus, able to frame the imminent economic slowdown in the Eurozone as not as bad as the initial COVID reaction. When pinned down on whether the PEPP program was drifting towards permanence, as the ECB drifted towards deficit monetization, he almost came unstuck, however. In his haste to say that the ECB was targeting inflation, by creating a healthy liquidity backdrop, he also said that the level of inflation will guide the ECB on when to exit. The PEPP was never conceived as an inflation targeting tool, it was just an emergency response. Lane now tries to make it a more permanent feature, by default of inflation rather than pandemic permanence.
Clearly, Lane and Lagarde intend to mix mission statements for various monetary policy tools as they mix pandemic response together with inflation targeting. It would appear that the continued poor inflation performance will be the excuse to make monetary policy easing permanent, whilst enabling the massive fiscal stimulus which Lane believes is required. He was quite clear that the low-interest cost, created by the ECB, is something that should encourage fiscal policymakers to go Big and Long with the Next Generation EU fiscal stimulus.
If the Eurozone’s foster children are behaving themselves, then, so are their adoptive parents. The Bundesbank recently issued a very downbeat view of the German economy for the rest of the year. An economic contraction would not surprise the Bundesbank. This will, of course, give German policymakers an excuse to not be as generous with the fiscal transfers, to their adopted Spanish and Italian children, but it will prevent them from lecturing the kids about the merits of Black Zero fiscal austerity. On the contrary, the Bundesbank sees significant scope for fiscal stimulus, with the proviso that budget stabilization measures are put in place for 2021. Consequently, the Bundesbank will not resist further easing from the ECB as long as it is tagged as temporary and pandemic related.
Whilst the putative foster parents and problem children settle down, for the long run, the ECB must, by default, adjust its monetary policy framework accordingly. This adjustment can be seen forming in the recent guidance. Whilst there may be no consensus on what blend of emergency and long-term financing programs to apply, there is consensus that a blend is required. There is also consensus that there is no need for the kind of shock-and-awe easing seen, when the pandemic emerged in February, although Mr. Market may be disappointed to find this out at the December meeting.
As an example, of the blending consensus, Ollie “Rehnfeld” Rehn has opined that: “the context for the forthcoming decision in December is not whether we will decide on further additional accommodation in monetary policy, it is rather which instruments, in which scale and duration, will best serve the purpose.”
Pablo Hernandez de Cos has said, of the blend, that: “it’s important that we maintain the flexibility in the execution of our program during this longer time frame to avoid problems of financial fragmentation.”
Of the blend, Christine Lagarde has said that: “what is really important is that we make sure that the financing conditions are stable, are conducive to economic recovery as it comes,” and that economic agents must “not only know that the level of financing is going to be there but that it will be available for a period of time that will last long enough.” The latest COVID-19 vaccines are not a game-changer, in her view, and the Eurozone economy will remain on the backfoot in varying states of lockdown well into 2021.
Isabel Schnabel has succinctly defined the blend as a process of “defining what is the intensity of purchases that is needed to preserve historically low financial conditions?”
Thus, a blended decision from the ECB will be highly likely at the December Governing Council meeting. This blended decision must, however, also be seen through the eyes of an architect of the European Project. The blend must be in the interest of the advancement of this project.
(Source: OMFIF, caption by the Author)
This author cannot avoid further-commenting on the occasion of the retirement of Yves Mersch as the Eurozone’s and the ECB’s moral compass and oracle respectively. He has been there since the Maastricht Treaty was legislated into life and has steered the European Project, with a firm but always democratic hand, along the way. Mersch has upheld the law and democracy, whilst those around him have often suborned and subsumed them to their own agendas. He will be hard, if not impossible, to replace and the ECB and the Eurozone are much the worse for his passing.
The great European statesman and central banker gave a reminiscence, recently, before he moves off, to join the Pantheon of the European greats, alongside Mario Draghi and a few other Europeans. As always, his words were apocryphal.
Mersch endorses further monetary policy easing and would abhor the adoption of a Fed style American monetary policy framework by the ECB. He would turn in his grave if the ECB allowed the “Banksters” to use the emergency stimulus to pay handsome dividends. In his view, since the ECB devolves its legitimacy from the democratic process it must, therefore, follow this process to embrace Climate Change and Cryptocurrencies into its monetary policy framework. In the face of these new imperatives and the ever-present threat of fragmentation, Mersch believes that further European treaty changes, ratified at the national parliamentary level, will be needed to keep the Eurozone together and the European Project alive.
On the subject of his heroes, Mario Draghi is in Mersch’s top one. He credits Draghi’s “do whatever it takes” moment as saving the Euro currency and the Eurozone itself. Christine Lagarde and her consensual style get no plaudits from Mersch because she is a neophyte and her job is incomplete. Neither does he criticize Lagarde for her more obvious failures to date. He leaves his post confident in the knowledge that the Euro and the Eurozone have been saved; and also that the bright future currently remains in the democratic hands of the Eurozone peoples. Job done Yves, please write your memoirs soon.
Mersch continued his valedictory guidance roadshow in an interview with the Financial Times. This interview set the context for his passing of the baton to fresh blood. The economic context is that the second wave of the COVID-19 pandemic will have different impacts throughout the Eurozone; which in total will not be as bad as the first outbreak but could easily feel as bad in the regions hardest hit. Fiscal policy remains the best antidote to the virus and the issue of debt monetization remains protected by law in the Eurozone. The banking sector must accept the ECB’s edicts, on capital adequacy and dividend payments, for as long as it subsists on the central bank’s support.
According to Mersch, any change in the inflation target and monetary policy framework must be discrete from the Fed’s, by nature of the fact that the ECB has a single mandate versus the Fed’s dual mandate. This will not preclude the Governing Council from changing the mix of monetary policy tools and their duration at the December meeting. Mersch is not a fan of further interest rate cuts since the reversal rate is not known to him but feels close at hand. He does favor lengthening the duration of the monetary policy response since the duration of the pandemic is now clearly longer than initially envisaged.
Finally, Mersch reminisced about the changes at the ECB during his time. He sees this transformation partly as a bi-product of the challenges encountered at the time. Ruefully, he notes that the ECB has been in crisis mode from Trichet’s presidency to date.
Mersch’s summation, in his reminiscences, clearly provides the context for the December Governing Council meeting. This meeting is as much about the context and his legacy, as it is about negotiating the next phase of the COVID-19 pandemic. Mersch has shown where the Eurozone and the ECB have come from and also where they are both headed. It is Lagarde’s job to get them there via this historic moment.
(Source: BIS, caption by the Author)
In terms of Mersch’s legacy, and enforcement of his doctrine, his replacement Frank Elderson appears to be a chip off the old block. Elderson’s maiden speech to EU policymakers contained the “do whatever it can” reference along with the legal disclaimer that these efforts must remain “within its mandate”. He’s pure Mersch with a hint of Draghi.
(Source and caption by the Author)
Both Mersch and Elderson must be watching the current standoff, between the purported EU democracies and the two Eastern European dictatorships, with interest. The EU fiscal stimulus links economic support with the rule of law and the democratic process. Italy, Spain, and Portugal have understood this to mean simply doing as they are told. Hungary and Poland are trying to veto the whole EU fiscal stimulus because they do not wish to abide by the democratic and legal addendums to the deal attached by Brussels.
(Source, caption and editing by the Author)
Ollie “Rehnfeld” Rehn is furious that the Poles and the Huns have frustrated the next phase of the European Project. Every dark cloud has a silver lining, however, so Rehn has taken this headwind as an opportunity to recalibrate the TLTRO component of the expected monetary policy easing at the December Governing Council meeting. No doubt, this recalibration will have an extended layer of permanence about it.
Like Rehn, ECB Vice President Luis de Guindos believes it is imperative that the EU’s Next Generation fund is implemented “swiftly” to mitigate rising redenomination risk.
It is ironic that the EU’s tactics, to ostensibly create a superstate by fiscal conquest, are being resisted by alleged dictatorships. Having observed Italy, Spain, and potentially Portugal surrendering to the Eurozone fiscal Blitzkrieg, supported with aerial supremacy from the ECB, Poland, and Hungary are nervous. Why shouldn’t they be? They have been sold out and invaded by their neighbors before throughout history.
Mersch and Elderson will be pleased that democratic principles are still upheld in the EU. This will make them less uneasy about the undemocratic leanings of the EU and its methods. This would, also, embolden them to support more monetary policy easing, by the ECB, if the alleged Eastern dictators hold up the fiscal deal or dilute its efficacy. The Eastern dictators have, however, been democratically elected and this must be also be recognized. The architects of the European Project may just have to accept, that there are democratic limits to expansion, at least for now. Perhaps, it is better to swallow the existing members of the Eurozone into a superstate before expanding further to the East.
The Germans have understood this logic and the historical precedents, that are being mirrored today, only too well. The German cabinet is split over the government’s interventionism. There is also rioting on the streets of Berlin against interventionism. Even when the COVID-19 vaccine is available, in Germany, it is clear that there will be strong resistance to taking it by many based on the current protests. A vaccine is, thus, no panacea in a democracy. The Germans must now decide if COVID-19 or democracy is more important. France is undergoing the same dialectic. The EU and the ECB are holding their breath. This is not the Christmas European policymakers had wished for.
(Source: AZQuotes, caption by the Author)
The impact of the COVID-19 virus on Germany has been one of the most transformational of all the global economies. Going into the crisis with a fiscal surplus gave Germany a slight advantage. This edge was swiftly eroded in fiscal support measures for its industrial base and its furloughed workers. In 2021, Germany is expected to borrow 70% more than it did in 2020. Beggars cannot be choosers, so this change in its fiscal position is making Germans warmer towards prospects the anathema of a period of negative interest rates from the ECB.
Germany will be paid to transform its economy. What’s not to like about this, if you’re German? This is yet another benefit of the single currency, to be added to the big benefit of one’s immediate neighbors being unable to competitively devalue. Germans, now, may be even more willing to fiscally transfer funds to their neighbors, as a form of vendor financing, since they get paid to do so.
Germany has noted that the Green New Deal will drive both the Eurozone economy of the future and much of the global economy. Germany is therefore transforming itself to align with these Green fundamentals and the fiscal stimulus flows that will follow. It is also being paid to transform with negative interest rates.
(Source: DW.com, editing by the Author)
Cleverly, Germany is playing its Brexit and Green New Deal cards as one Joker. German-based car manufacturers will exclusively focus on electric vehicles, whilst the dirty vehicles will be made in the UK post-Brexit. Since Britain has less ambitious emission targets for new vehicles, than the EU post-Brexit, and is desperate for jobs post-Brexit, Boris Johnson has been keen to oblige Germany Inc. in its automobile transformation strategy.
So, Germany has effectively, made peace with its old European nemesis, whilst saving its own industrial base, and avoiding any future imperial hostilities about who has access to hydrocarbons.
Germany has, also, driven a little wedge into the old Anglo-Saxon Trans-Atlantic nemesis that has been its undoing throughout the Twentieth Century. The Anglo-Saxons are now a little divided, and hence, a little bit conquered; since their famed “Special Relationship” has been framed by Brexit rather than the two World Wars. Having secured one side of the Atlantic, German can now embark on a sea-borne political adventure on the other side of the Pond. One has the sense that Germany is getting a better outcome from this Brexit deal so far.
The German transformation has not left the Bundesbank untouched either. President Jens Weidmann is now a fully committed convert to what this author has called Green QE. He recently extolled the virtues of all central banks who buy Green Bonds, which are independently rated and backed with real tax revenues rather than hypothecated ones.
With his other eye on the flames in the Berlin streets and the metaphorical ones in the Bundestag, Weidmann also pronounced that he is totally on-board with more monetary policy easing from the ECB.
(Source and caption by the Author)
Christine Lagarde has not ignored Yves Mersch’s warnings. She has listened and is, therefore, finely attuned to the political forces in Europe that could lead to fragmentation if they are allowed to get out of control. She used the latest political chaos and lockdown escalation to remind EU policymakers of their democratic obligations to legislate the promised joint fiscal stimulus into life.
Lagarde has, once again, risked another yield-spread hiccup, by opining that the ECB is only capable of providing a sufficiently liquid backdrop. In her view, it is the fiscal policymakers’ job to move the economic needle, thereby, replacing fragmentation with growth. Citing Goethe as inspiration, she also swiftly reverted to the stats in the latest Eurobarometer survey on the state of public opinion and democracy in the EU. According to these stats, 88% of Europeans are in favor of a joint fiscal stimulus to lead them out of the pandemic. The joint fiscal stimulus, thus, has a semblance of democratic legitimacy that should prompt immediate action. Presumably, the non-consensus 12% are rioting in the streets of Paris and Berlin!
(Source: question and answer by the Author)
Also tucked away, in Lagarde’s call to fiscal arms, was her opinion that, since the COVID-19 vaccine won’t arrive in time and the damage to the Eurozone economy will be long-lasting, a more permanent form of joint fiscal stimulus will be needed. This stimulus should go towards the technologies of the future that will guarantee employment and a Green Economy for all Europeans. Clearly, ECB supported financial conditions will also be needed, although she didn’t mention this. This future is called Modern Monetary Theory (MMT) for those who would like a name for it.
When Yves Mersch started out, on his noble European quest, the EU and its antediluvian form of MMT went under such acronyms as EEC and CAP. They were also principally Cold War initiatives, sponsored and seeded by America, through the American Committee on United Europe (ACUE). All of them were conceived as permanent and durable constructs. Now, they have become self-financing and self-serving in an exclusively European context. The A in ACUE has been erased from history and the C is now in the process of being lost, through integration, by people like Yves Mersch and Mario Draghi, to leave a permanently reconfigured EU.
Perhaps, one day in the future, when the European Project is finished, its principles will be known as European Monetary Theory (EMT) to define them clearly from other global fighting brands of the same thing in the post-COVID Cold War that is now in its early stages.
(Source: Economist, caption by the Author)
The conflation of monetary and fiscal policy, in European Monetary Theory, is becoming institutionalized, already, in the smaller Eurozone countries who will be net recipients of monetary and fiscal transfers going forwards into perpetuity. These nations have dispensed with all semblances of trying to make their central banks look independent from their respective finance ministries.
The list of Eurozone central bank presidents/governors, who were once finance ministers, now includes Greece, Malta, and Portugal. The reciprocal drift is also evident at the ECB with former finance ministers Christine Lagarde as President and Luis de Guindos as Vice President. This drift is not just limited to the Eurozone. Across the Atlantic, where America is executing its own idiosyncratic form of Modern Monetary Theory, involving average inflation target make-up and maximum employment, Janet Yellen is ostensibly going the other way from Fed to Treasury.
As the personnel at Eurozone central banks become interchangeable and are interchanged, with their respective finance ministries the line between fiscal and monetary policy is being erased rather than blurred. One of something is a coincidence, two of something is a developing pattern. Three of something is a trend. More than three of the same something is a strategic program. The work in progress, begun when Yves Mersch was in his youth, is at an advanced stage. COVID-19 has given it a nudge.
Executive Board member Isabel Schnabel appears to the person who is taking the baton from Yves Mersch, whilst the central bank remains in crisis mode of a different nature from those purely financial crises of old. It is, therefore, more instructive to frame the upcoming December Governing Council meeting through her pre-meeting guidance.
From the outset, it is clear that Schnabel intends the ECB’s ostensible pre-commitment to ease at the next Governing Council to appear as thoroughness rather than perceptions framing per se. This thoroughness has been reinforced with the copious research, in the form of working papers, that have accompanied her verbal guidance.
(Source: ECB, caption by the Author)
This support was led by Philip Lane and his “Lower-For-Longer” mantra with pictorial guidance for the perplexed. His eponymous presentation provided the numbers and logic for Mersch’s hint that the monetary policy response to the pandemic will be extended. This over-simplification, however, does what Schnabel was to impart in the frame of reference no favors. Schnabel’s message was on s timeline that involves a crisis that pre-dated COVID-19 and was then hijacked by it. This underlying crisis, unfortunately, will still be around when the pandemic has run its course. In fact, the pandemic will make the underlying crisis even worse, thereby, calling for a sustained response which may surprise those who think it was just all about COVID-19 and holding out until the vaccine was distributed.
Lane’s picture book was supported by the Survey on the Access to Finance of Enterprises in the Euro Area. This painted a bleak picture of credit tightening for enterprises lacking in scale and renewed credit for enterprises of scale who didn’t want to use it for growth.
A second financial stability report, entitled COVID-19 and monetary policy: Reinforcing prevailing challenges reminded fiscal and monetary policymakers that they are, in fact, joined at the hip pro-cyclically. Even the phasing out of emergency stimulus must, therefore, involve leaving in place a combination of fiscal and monetary policies that are the most complementary to avoid triggering a recession. To this author, this advice just sounds like an apology for Modern Monetary Theory (MMT).
A third report, entitled Banks, low interest rates, and monetary policy transmission, explained how and why the monetary policy transmission mechanism is being choked-off by the banks at the lower interest rate bound. Apparently, banks stop lending at the lower bound because the lending-spreads they earn no longer compensate them for the risk from an economic shock to their equity capital. COVID-19 could, thus, be seen as an exogenous shock that has just triggered said risk to their capital bases that has choked off their lending. This report informs why the ECB is unlikely to cut interest rates further, at this point, and also why the banking sector is a potential source of the next financial crisis if it is not supported.
A press release, about medium-term vulnerabilities, then neatly explained how all the risks explained in each report are negatively impacting the corporate and banking sectors within the Eurozone.
ECB Vice President Luis de Guindos also added his context, which, ostensibly, frames the ECB’s imminent easing of monetary policy as being for the purpose of maintaining the flow of credit. A mix of tools, with provision for the banking sector, will supposedly sustain the flow. Governing Council member Gabriel “Gabz” Makhlouf highlights uncertainty, as the main issue, in a situation where positive vaccine news vitiates against the new lockdowns.
Isabel Schnabel’s guidance was more nuanced than Lane’s, De Guindos’s, and the accompanying staff research. She framed the December meeting purely in terms of the crisis that the ECB is living through. Pre-COVID, it was a crisis of disinflation, trade wars, and low productivity. This environment had already got the ECB knocking on the door of the Zero Lower Bound. The COVID-19 pandemic then layered in a massive health crisis, which forced the ECB to test the limits of unconventional monetary policy at the lower bound.
Schnabel noted that the ECB has experienced transmission problems, signaling problems, and expectation problems which all react in a non-linear way with discrete time lags. The impacts have been profound. Consequently, the impacts on the new monetary policy framework will be profound. Thus, observers of the ECB should not expect any recent good news on vaccines to signal a return to pre-COVID-19 normality, since this situation was anything but normal to begin with. The ECB was dealing with a new normal even before COVID-19 occurred. The new monetary policy framework has, thus, been impacted by COVID-19 too. One should, therefore, be expecting something profound from the ECB in relation to its new monetary policy framework. This is not the beginning of the end, of COVID-19, but rather a new beginning for monetary policy. Thanks to Lane, it may appear similar to the Fed’s lower-for-longer new monetary policy framework but it is not.
Even the Governing Council’s more Hawkish member is prepared to be persuaded by Schnabel’s logic at the next Governing Council meeting. Robert Holzmann has stated for the record that, whilst he remains confident of a full economic recovery in 2021, he is willing to shuffle the mix of programs, in the short-term.
Philip Lane re-iterated Schnabel’s plan and its justification. His guidance explained how the ECB is steadily moving through the evolving phases of the pandemic and is now in the position of sustaining the money supply so that the medium-term inflation convergence goal can be “copperfastened” as he quaintly puts it.
A question mark, in relation to copperfastening, still lingers over the banking sector and its ability to transmit its problems to the real economy through a financial crisis.
(Source: imgflip, caption by the Author)
ECB Executive Board banking sector Czar Fabio Panetta has gingerly decreed that the ECB is tiptoeing around the banking sector’s consolidating gladiators. Pretending that the sector is healthy, he opined that some banks will be allowed to resume paying dividends again. This case-by-case approach suggests that the ECB may start playing Caesar by deciding which banks can be acquired and which banks will do the acquiring. Obviously, those that are given the thumbs-up by being allowed to pay dividends will do the buying (cheaply!) of those that get the thumbs-down. Mr. Market will swiftly move to pick the dividend-paying winners and non-paying losers. As he does so, there is a risk that price discovery triggers a general risk-off move, in the banking sector, which becomes an economic headwind. Clearly, the Dutch are preparing for the contest, since their central bank has recently advised the Dutch banks to swiftly account and provision for their non-performing loans.
Evidently, Philip Lane’s Copperfastener is a bandage to affix to the gaping wound in the Eurozone banking sector. Hopefully, it will also cover Christine Lagarde’s mouth if and when she makes another mistake about yield spreads.