I always thought that Mario Draghi was a complete dunce on fundamental economics, but he has now sealed the case in his own words. The reason the ECB is about ready to unleash its own version of QE, it seems, is that “moar inflation” would facilitate a creeping default on euroland’s massive public and private debts—-an albatross that ranges from 350% to 500% of GDP for most of its member states:
“…(growth is constrained by) a debt level, which, both for the private and public sectors, is still elevated. And with low inflation, the real value of this debt does not go down as fast as it would if inflation were higher, so it makes the adjustment of the debtors, the deleveraging, more difficult.”
Historically, such primitive inflationism was the province of cranks and demagogues. From the pages of American economic history the likes of William Jennings Bryan, Father Coughlin and Huey Long come to mind.
But now such tommyrot is spoken out loud by the head of the ECB and self-evidently embraced by the Fed, the BOE, the BOJ and most of the other major central banks. This would be dangerous enough in the world of 25 years ago where central bankers had enormous sway, but had not yet extinguished all semblance of independence and honest price discovery in financial markets. After all, the “bond vigilante’s” of the early 1990s were not exactly compliasant tools of central bank policy.
But in a world where money markets and capital markets have become totally drugged, house-trained and subordinated to central bank policy the official embrace of such rank inflationism is down right alarming. To my knowledge, such incendiary words have not been uttered aloud by any important central banker in modern times.
So give Mario Draghi the Rudolf Havenstein Award for being the most destructive central banker since its namesake. And add a poke in the eye to the fast money traders who have piled on to Draghi’s “whatever it takes” ukase, and created the economically absurd graph shown below.
For all Washington’s infirmities of fiscal governance, there is simply no rational case that Spain is an equal credit risk under current facts and circumstances. More importantly, neither of these rivals in the fixed income dirty shirt laundry deserve a yield of just 180 bps on 5-year paper. Those are deeply negative returns after inflation and taxes—even if it is foolishly supposed that no extra return for sovereign credit risk is required in a world in which fiscal rectitude has been consigned to the dust-bin of history.
The global market for sovereign debt is variously estimated at $60-$80 billion. Virtually all of that paper is now being priced based on the words and liquidity machinations of central bankers, not the fundamentals of inflation, taxes, credit risk and future cash flows.
Now it comes to pass that one of the rank amateurs among the small posse of central bankers who run the world’s financial system has let the cat out of the bag. Namely, that after having enabled a massive and unsustainable build-up of global debt, the central bankers now aim to facilitate its default.
Unless you have your finger on the sell button 24/7 there is no possible reason for owning a government bond—-Spanish, US or any other. There is a reason that for nearly a century the Rudolf Havenstein Award was not much sought after. But in a world where Janet and Mario foolishly struggle to hit their inflation targets from below all bets are off.In the post below, Wolf Richter provides some further astute observations about the financial lunacy that has been embraced by Draghi and the rest of the central bank cartel.
By Wolf Richter At Testosterone Pit
When the ECB tweeted on April 3 that its Governing Council had been “unanimous in its commitment to using also unconventional instruments within the mandate to cope with prolonged low inflation,” it was threatening in less than 140 characters to deploy the same voodoo economics practiced with such ravaging success by the Fed and the Bank of Japan. They’ve inflated asset bubbles and wreaked havoc in many areas of the real economy.
During the press conference, ECB President Mario Draghi was jabbering on about “low inflation,” archenemy number one in his bold fight to cut real wages. And that’s what the wealthy Mr. Draghi, other central bankers, and those they represent want: cutting real wages surreptitiously and gradually, so that workers wouldn’t notice and rebel. So he complained at the press conference, in public, for everyone to see, that with low inflation, cutting real wages was tough: “And you know that prices and wages have a certain nominal rigidity which makes these adjustments more complex,” he explained.
An honesty the Fed never dared to exhibit when it inflicted waves of QE on American workers.
And there was another drawback of low inflation, he said. It had “to do with the presence of a debt level, which, both for the private and public sectors, is still elevated. And with low inflation, the real value of this debt does not go down as fast as it would if inflation were higher, so it makes the adjustment of the debtors, the deleveraging, more difficult.”
He was pushing the creeping default by governments, banks, corporations, and other big debtors on their “still elevated” debts. And low inflation was getting in the way of this creeping default. That’s what he said. And this hilarious cartoon by Merk Investments (with permission) indicates the mechanism by which he’d handle this delicate situation, and how Chancellor Angela Merkel would listlessly play along:
But why the sudden honesty? Especially since he even admitted that most of this low inflation was beneficial for the economy, noting that 70% of the reduction in inflation since 2012 was “due to lower energy prices and lower food prices.” That equates to a tax cut for the strung-out consumers.
Turns out, it wasn’t honesty that caused his diatribe. He was slamming the euro in his effort to verbally and singlehandedly devalue it faster than the Fed has been devaluing the dollar and the BoJ the yen. He was talking it down, practically massacring it. And right after the press conference, it actually dropped a smidgen to $1.36 only to shamelessly rise again a few days later to $1.39 before settling at $1.38 on Friday, higher than it had been before his euro bashing.
Draghi had once again pulled out his big bazooka and had shown it to the market. And after initially running scared, the market shrugged it off.
But what else could his threats of negative deposit rates and bouts of QE still accomplish? The goal would be to inflate asset values, but they have been inflating for years, and even the crappy bonds from periphery countries have soared and yields have plunged: Spain’s cost of borrowing is just as minuscule as the US’s cost of borrowing. The chart by Merk Investments shows that amazing trajectory. Five-year paper of both countries is now generating roughly the same ridiculously low yield.That’s what Draghi has accomplished with his “whatever it takes” threat – new bubbles in dodgy financial assets, record low borrowing costs for governments, financial repression for savers and bondholders, a real economy in the Eurozone that is just barely sputtering along, and a euro that now refuses to crash.
The countries that want a devaluation of the euro more vocally than any other are France and Italy. They have always solved their deficit and debt problems through regular devaluations. Now that they no longer control their own currency, they can only beg Germany and the ECB to relent, which has produced, among other crummy results, Draghi’s ineffectual verbiage.
A report from the asset management and investment banking division of Groupe BPCE, the second largest bank in France, predicts what daredevil voices at the maligned margin of financial analysis have worried about for a while: another financial panic. Read….What Happens When ‘All Assets Have Become Too Expensive?’
Read this post at Testosterone Pit.
