The European Central Bank Commits Monetary Suicide

Yesterday the European Central Bank (ECB) announced an expanded 1.1 trillion euro (US$1.3 trillion) asset purchase program to start in March 2015 and continue through September 2016 (19 months) that will include the purchases of sovereign (national government) debt. It plans to purchase roughly 60 billion euros ($68 billion) worth of securities monthly, up from about 13 billion, with most of the additional purchases to be allocated to sovereign (national government) debt with a quarter expected to end up in scarce German bunds. The purchases will be restricted to investment grade issues, which would mean no purchases at all if the condition were applied diligently, and will include non-investment grade issues like Greek bonds if they have an ongoing budget/spending agreement with the ECB-IMF in place.

The purchases will be limited to covered bonds, asset backed securities, and government debt (i.e., equity not included). A day prior, the Bank of Japan (BOJ) announced that it was going to continue its own asset purchase program (mainly JGB’s), forcing insurers and other institutions to seek yields abroad.

The ECB program is twice as large as expected and the governing council appeared to be on side, including the German reps, owing to Draghi’s apparently skilled diplomacy and risk sharing idea – where some portion of the losses would be born by the national central banks rather than the ECB.

The BOJ’s pledge to increase its monetary base at the same 80 trillion yen per year ($676 billion) pace that it has for the past couple of years seems like a bit of a letdown though given their bullish rhetoric to increase monetary interventions in 2015 following the Fed’s final QE3 bond purchase.

Stock markets reacted positively around the globe, though gains were tempered (perhaps the news was a tad overly telegraphed!); bond yields ratcheted up a bit except in Germany and Switzerland where they have gone negative in some instances; the euro collapsed along with most currencies against the USD; the precious metals held up well; and the economically sensitive commodities fell.

A far more mixed day than I originally anticipated…but then, again, the moves were widely expected.

Fund managers and other institutions have been front-running this news for over a year.

Uh oh!

Ostensibly, the aim of the policy (intervention) is to combat deflation, or falling inflation, which the policymakers believe “reflects sluggish demand and can paralyze an already weak economy — a problem that has long afflicted Japan, the world's third-largest economy” (click here for source).

It is aimed at boosting private sector investment and consumer confidence simultaneously, just like the Fed did in the U.S., proving, “the actual impulses for growth from sensible conditions must be created, and can be created, by politicians”, said Merkel. Indeed, one source says, “The US Federal Reserve launched three rounds of bond purchases that were credited with helping jump-start the US recovery.”

According to Bloomberg, “Global central banks are petrified of deflation,” said M&G’s Doyle, whose firm oversees the equivalent of about $389 billion. “The real effectiveness of QE is through the portfolio-rebalancing effect. The world is running out of positive-yielding government bonds.”

It is a sad day when crap like this fools people.

You think an idea has died but most people are too dull to recognize it in a different wardrobe.

Like every good Keynesian, Merkel believes that throwing fresh money at sovereign governments can “create” growth? But the myth that anyone can produce wealth this way has long been exploded; as has the myth that government can produce wealth. Government can’t create wealth because it cannot calculate whether what it is doing is efficient or economic, or whether it is wasteful. It can’t coordinate resources inter-temporally between the various stages of production without knowing the prices of capital goods or the natural rate of interest. Nor can governments create wealth by expanding money supply any more than they can turn stone into bread just by reading enough interpretations of Keynes.

All of this is pure noise.

The True Aim of the Interest Rate Suppression

What has weighed on Japanese growth and Euro growth is the same thing as that which is now weighing on growth in the US: a malignant public sector bureaucracy and out of control public debts.

Falling prices do not plunge the economy into a debt-deflation spiral, they are the product of gains in productivity –i.e., true growth is basically an increase in the supply of goods, greater output per capita.

The debt-deflation that is apparently feared by central bankers is in the first place a risk that was caused by fractional reserve banking - a concept that isn’t broadly feasible in a free and unregulated market - and which is ultimately propped up by deposit guarantees, legal tender laws, taxpayer funded bailouts, and other monopoly legislation. The over use of the policy of suppressing interest rates has incentivized the accumulation of too much public debt everywhere. The real reason for the ECB’s QE policy, besides having built it into the market (leaving no choice but to follow through on expectations), is to obfuscate the insolvency of the “fiscal cripples” that form the EU, and kick the can down the road.

There are long-term reasons as well, like the continued centralization of banking across the euro zone.

But the fear of deflation is an irrational fear fanned by a western alliance of central bankers to hide the fact that they are really just holding out a lifeline to the world’s biggest and most insolvent governments.

For many months now in the TDV newsletter I have been writing about what has been happening in the US, and why it is not the same as growth. Now the ECB wants to do the same to the European economy.

The US economy is not growing faster, its asset markets are just being inflated faster.

Indeed, this fairy tale is part of what I believe is an even greater delusion.

The fact is that Europe (and Japan) has not inflated nearly as much as the rest of the world thinks, and not nearly as much as the Fed has, even in the latest year! The evidence strongly suggests that Japan and Switzerland sterilized their asset purchases while the US and UK did not.

And the verdict is out on whether the ECB plans the former or latter type of QE. This delusion is going to crush yen bears and dollar bulls in one fell swoop, and we warn you now to listen carefully.

Nobody owns the yen!

The Yen makes up the smallest allocation in everyone’s portfolio.

Central banks own just 4% as currency reserves. And same with Japanese Government Bonds: as of a 2011 IMF report foreign ownership of Japanese government bonds amounted to just 5%.

On the other end of the spectrum is the US dollar, which makes up 61% of central bank reserves (down from > 70% at the outset of the euro experiment 1999-2001), and where foreign ownership of Treasury securities approaches the 40% level. Unlike the US dollar, which is over-owned, over-printed, and probably lies in bundles under every hooker’s mattress, Yen is scarce, like Cesium! To boot, the Japanese money supply grew only 4% last year, despite all the rhetoric, compared to over 5% for Europe, and 7% in the US. It has grown just 22% in the past 5 years, cumulatively, compared to 33% for the Euro and over 70% for the USD!

Over the past ten years the BOJ has inflated money by just 32%! That compares to 102% for the Euro area and well over 100% in the US –the US has expanded money by 100% just since 2008- in roughly the same time period. The Swiss numbers for M1 are similar to the EU.

In almost every sense, the Fed has waged the most consistently aggressive monetary policy in the developed world, especially in the post 2008 period, where it has increasingly mirrored policies of countries like South Africa, Mexico, India, Indonesia, and Poland.

Even China has been pursuing a sounder money policy than the Fed since 2008.

Like we said, the US is not growing faster, it is inflating faster.

QE Not the Same as Sterilized Asset Purchases

I first highlighted this delusion months ago in order to point out how the US treasury market and USD were benefiting from the relative suppression of European yields. In my analysis, strength in both the US dollar and US Treasury bond reflects the fact that yields on euro government debt have disappeared. This trade then was the source of the dollar’s rally against the Euro.

If you listen to most media about this, you will come away with the idea the USD has been going up because the Fed has tapered and the US economy has gained traction while the Euro and Yen have been falling because their economies are relatively weak and their central banks have been printing money like mad. Indeed, the decline in the euro in response to the ECB’s press release today should have been more guarded in light of the opposite truth. The market has been wrong about who is really printing money and who is dancing the twist. It is deluded about most things that support the dollar.

In light of this plus the fact that this overly expected event won’t start for another month or two, and also because the Japanese central bank is lowballing its original promise there is risk of a hiccup.

Regardless, don’t be fooled into thinking that this policy is going to help the private economy.

Inflation is what these cats want, and inflation is what they are going to get, good and hard.

One day soon they will be begging for deflation.