March 13, 2016
A Whiff of Panic
Ahead of Thursday’s ECB meeting, there was a widespread consensus that Europe’s chief printing press supervisor would make up for the alleged “mistake” of under-delivering on monetary lunacy last time around. Therefore, a sizable dose of fresh absurdities had to be expected, with only small disagreements on the details. It is fair to say the man didn’t disappoint.
There was an even greater consensus that the punters populating the casino were eagerly awaiting such news, and that they stood ready to deploy wagon-loads of money (mostly other people’s) in the direction wished for by the central planning puppeteers. This particular detail didn’t quite work out as expected, at least not at first. For instance, after an initial swoon, the ECB’s very own confetti became more rather than less expensive.
June euro futures, 20 minute candles. At first, the euro did what it was “supposed” to do – and then it went “yen” on the Dragon and his minions – click to enlarge.
Similar scenes played out elsewhere. Here is for instance a 20 minute chart of the June Bund futures contract, which was subject to a similar sudden change in market opinion:
Instant hangover in Bund futures – click to enlarge.
Other playthings were similarly impacted, from the DAX to gold. All the stuff that used to habitually react in a certain manner to more ECB largesse essentially did the opposite of what it was “supposed” to do.
Readers may recall the last time when a similar thing happened. That was on occasion of Kamikaze Kuroda’s attempt to smite putative yen bulls by cutting the BoJ’s deposit rate into negative territory.
That didn’t quite work out as planned either… – click to enlarge.
Kuroda “only” decided to emulate the fashionable new European central planner absurdity of imposing negative interest rates, which means that according to the Keynesian rule-book, he “didn’t do enough”. However, it was a surprise move, as he seemingly had publicly ruled out negative rates only one week earlier.
As we have previously remarked, this adverse (from the perspective of the planners) market reaction had to be taken as yet another sign that the irrational faith of market participants in central bankers is beginning to crumble.
Evidently Draghobert concluded from this that he had to throw the whole kitchen sink and then some at the markets, so as to dispel the misguided notion that he was “running out of ammunition” (this idea is indeed misguided – there is no limit to the madness central bankers can inflict). This is what came over the wires ahead of his press conference:
“At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:
(1) The interest rate on the main refinancing operations of the Eurosystem will be decreased by 5 basis points to 0.00%, starting from the operation to be settled on 16 March 2016.
(2) The interest rate on the marginal lending facility will be decreased by 5 basis points to 0.25%, with effect from 16 March 2016.
(3) The interest rate on the deposit facility will be decreased by 10 basis points to -0.40%, with effect from 16 March 2016.
(4) The monthly purchases under the asset purchase programme will be expanded to €80 billion starting in April.
(5) Investment grade euro-denominated bonds issued by non-bank corporations established in the euro area will be included in the list of assets that are eligible for regular purchases.
(6) A new series of four targeted longer-term refinancing operations (TLTRO II), each with a maturity of four years, will be launched, starting in June 2016. Borrowing conditions in these operations can be as low as the interest rate on the deposit facility.”
When we became aware of this extensive list of fresh depredations, our first thought was “these guys are in total panic”. Even if one erroneously believes – as the members of the ECB council evidently do – that prosperity can somehow be conjured into being by increasing the money supply and suppressing interest rates to absurd levels, it is a mystery why they would believe that even more of the same is needed right now:
There is panic on the Titanic – but why? Money supply growth in the euro area has accelerated to nearly 14% year-on-year, a level only briefly surpassed at the height of the two previous major credit booms. And we know how those ended, don’t we? – click to enlarge.
Market Reaction and Economic Impact – Where to From Here?
Assorted sell-side analysts have retrospectively tried to explain their failure to foresee the “negative” market reaction (contrary to them, we think it is definitely not negative for inhabitants of the euro area when the purchasing power of their currency increases and market interest rates move up instead of moving down to even more bizarre levels).
Unexpected market signals…
Specifically, they were referring to something Draghobert said in his press conference about not wanting to push negative rates on the deposit facility even further into negative territory from their current level of minus 40 basis points. He probably did this because Europe’s commercial bankers must by now have inquired whether ECB council members have lost their mind.
Euro Stoxx bank index, daily – click to enlarge.
To be fair, negative rates on the deposit facility were hardly the only, and possibly not even the main reason for bank stocks to come under pressure. However, there has been quite a relief rally in bank stocks today, adding to the gains of the recent bounce from severely oversold levels. We think this has indeed something to do with the perception that the penalty rates imposed on bank deposits with the central bank won’t be increased further.
Moreover, let us not forget that there is now a new form of TLTRO which allows commercial banks to borrow from the ECB at negative rates. In other words, euro area banks have just been granted a huge subsidy presumably designed to offset the impact of negative rates on the deposit facility.
The idea is of course to incentivize banks to increase their lending – they now have the possibility to stoke credit demand by offering loans at extremely low interest rates, while still able to achieve a fairly decent interest margin. Whether this ploy succeeds remains to be seen, but surely some borrowers can be enticed by even lower borrowing costs.
Let us assume that this scheme does have the intended effect. What would this mean? Given the ECB’s paltry 1% reserve requirement, banks can theoretically extend credit from thin air at a rate of 100 euros for every euro they have on deposit. In other words, they can in theory expand credit by amounts that would positively dwarf their reserves on deposit with the central bank.
It is highly unlikely that the banks will get “fully loaned up” in terms of the reserve requirement, not least because new capital requirements represent a significant obstacle to such a huge expansion of credit. Assuming though that credit expansion does get a shot in the arm, what would it achieve?
For one thing, one would have to expect aggregate economic data to improve, as they always do on such occasions. After all, “economic activity” is bound to increase when credit expands. This is essentially all aggregate economic data are measuring -namely, “activity”. They are not telling us anything about the quality of said activity.
Euro area composite PMI – weakening in spite of EUR 60 billion in QE per month over the past year. Indicators like this one may well revive, but what will it really mean? – click to enlarge.
The problem is of course that a large chunk of the economic activity that takes place during boom periods is simply capital consumption masquerading as “growth”. So if the ECB’s latest ploy “succeeds”, it will only invite even more capital misallocation. This will feel good for a while, but it is apodictically certain that it will lead to even greater woes down the road – if it succeeds that is.
There is still another possibility, based on an idea we have mentioned on previous occasions: it is quite possible that the European – and indeed the global – pool of real savings is by now exhausted to the point at which no amount of monetary pumping will suffice to revive economic activity. We cannot measure the state of the pool of real funding, but we can infer quite a bit from observing what happens in the wake of additional monetary easing measures.
Should that be the case, we would expect the ECB’s recent actions to have surprisingly little effect on the real economy. In that case we should see faith in central bankers to continue to falter quite rapidly.
It remains to be seen how the latest interventions by the ECB will affect markets and the economy in the near to medium term – the initial reaction seemed negative, but one day later it has become more “mixed”, as risk assets have swiftly recovered. Even that is not telling us much yet, but it may be a first sign that renewed bubble activities will be set into motion.
Contemporary super heroes
However this turns out, there remains the important point that the market economy is continually prevented from adjusting to reality by the incessant interference of central planning agencies. The longer this continues, the more profound the eventual catastrophe will be.
There once was a time when economists would have been in an uproar upon witnessing the shenanigans of today’s central bankers.Nowadays they are not only acquiescing to them, they are actively demanding more and more intervention. Instead of being the voice of reason warning of the dangers such policies harbor, they have become cheerleaders for them. It is only a very small consolation that they will eventually be discredited. The cost will be extremely high.
As Ludwig von Mises noted, economists were once expected to strenuously object to the policies espoused by monetary cranks:
“There are men who are commonly stigmatized as monetary cranks. The monetary crank suggests a method for making everybody prosperous by monetary measures. His plans are illusory. However, they are the consistent application of a monetary ideology entirely approved by contemporary public opinion and espoused by the policies of almost all governments.
The objections raised against these ideological errors by the economists are not taken into account by the governments, political parties, and the press.
It is generally believed by those unfamiliar with economic theory that credit expansion and an increase in the quantity of money in circulation are efficacious means for lowering the rate of interest permanently below the height it would attain on a non-manipulated capital and loan market. This theory is utterly illusory. But it guides the monetary and credit policy of almost every contemporary government.”
Our assessment remains that the lunatics have taken over the asylum.
This article was posted: Sunday, March 13, 2016 at 9:27 am