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The appointment of Christine Lagarde as president of the ECB has been greeted with euphoria by financial markets. That reaction in itself should be a warning signal. When risky assets soar in the middle of a huge bubble due to a central bank appointment, the supervising entity should be concerned.Lagarde is a lawyer, not an economist, and a great professional, but the market probably interprets correctly is that the European Central Bank will become even more dovish. Lagarde, for example, is a strong advocate of negative rates.

Lagarde and Vice President De Guindos have warned of the need to carry out measures to avoid a possible financial crisis, proposing different mechanisms to mitigate the shocks created by excess risk. Both are right, but that search for mechanisms to work as shock buffers runs the risk of being sterile when it is the monetary policy that encourages excess. When the central bank solves a financial crisis by absorbing the excess risk that the market once took it does not reduce it, it only disguises it.

Supervisors ignore the effect of risk accumulation because they perceive it as necessary collateral damage to the recovery. Risk accumulates precisely because it is encouraged.

Draghi said that monetary policy is not the correct instrument to deal with financial imbalances and macroprudential tools should be used. However, it is the monetary policy which is causing those imbalances when an extraordinary, conditional and limited measure becomes an eternal and unconditional one.

When monetary policy disguises and encourages risk, macroprudential measures are simply ineffective. There is no macroprudential measure that mitigates the risk created by negative rates and almost three trillion of asset purchases.

…click on the above link to read the rest of the article…

The ECB’s Quantitative Easing was a Failure–Here is What it Actually Did

January 14, 2019

THE ECB’S QUANTITATIVE EASING WAS A FAILURE — HERE IS WHAT IT ACTUALLY DID

The main reason why the ECB quantitative easing program has failed is that it started from a wrong diagnosis of the eurozone’s problem. That the European problem was a demand and liquidity issue, not due to years of excess.

The ECB had been receiving tremendous pressure from banks and governments to implement a similar program to the US’ quantitative easing, forgetting that the eurozone had been under a chain of government stimuli since 2009 and that the problem of the euro-zone was not liquidity, but an interventionist model.

The day that the ECB launched its quantitative easing program, excess liquidity stood at 125 billion euro. Since then it has ballooned to 1.8 trillion euro.

“Only” after 2.6 trillion euro purchase program and ultra-low rates.

Eurozone PMIs are atrocious. The euro-zone index falls from 52.7 in November to 51.3 in December, well below the consensus forecast of 52.8. More importantly, France’s PMI plummeted from 54.2 in November to a 34-month low of 49.3.

Unemployment in the euro-zone, at 8%, is double that of the US and comparable economies. Youth unemployment rate remains at 15%.

Economic surprise has plummeted as the ECB balance sheet reached 41% of GDP (vs 21% of the Fed).

More than 900 billion euro of non-performing loans remain in the banking system, which keeps a trillion euro timebomb in its balance sheets (read). A figure that represents 5.1% of total loans compared to 1.5% in the US or Japan.

Deficit spending is rising. Government debt to GDP has risen to 86.8%.

The number of zombie companies -those that cannot pay interest expenses with operating profits- has soared to more than 9% of all large quoted firms, according to the BIS.

…click on the above link to read the rest of the article…

The Eurozone Banks’ Trillion Timebomb

November 19, 2018

The Eurozone Banks’ Trillion Timebomb

Eurozone banks have fallen dramatically in the stock market despite the results of the stress tests carried out by the ECB, and the EU Banks Index is down 25% on the year despite year-long bullish recommendations from almost every broker. This should not surprise anyone because we have seen in the past that these tests are only a theoretical exercise. Moreover, stress tests’ results are widely challenged, and rightly so, because the exercise starts with the most ridiculous premise in economics: Ceteris Paribus, or “all else remaining equal”, which never happens. Every asset manager knows that risk builds slowly and happens fast.

Disappointing earnings, rising risk in the eurozone as well as in their diversification markets such as emerging economies, weak net income margins and low return on tangible equity are factors that have contributed to the weak performance of European banks. Investors are rightly suspicious about consensus estimates for 2019 with expectations of double-digit EPS growth rates. Those growth rates look impossible in the current macroeconomic scenario.

Eurozone banks have done a good job of strengthening their capital structure, reaching almost a one per cent per annum increase in Tier 1 core capital. The question is whether this improvement is enough.

Two factors weigh on sentiment.

. More than EUR104 billion of risky “hybrid bonds” (CoCos) are included in the calculation of core capital.

. The total volume of Non-Performing Loans across the European Union is still at around EUR 900 billion, well above pre-crisis levels, with a provision ratio of only 50.7%, according to the European Commission. Although the ratio has declined to 4.4%, down by roughly 1 percentage point year-on-year, the absolute figure remains elevated and the provision ratio is too small.

…click on the above link to read the rest of the article…

Market crash? Another red card for the economy

October 13, 2018

Market crash? Another red card for the economy

A few months ago I wrote this article at the World Economic Forum called “A Yellow Card For The Global Economy“. It tried to serve as a warning on the rising imbalances of the emerging and leading economies. Unfortunately, since then, those imbalances have continued to rise and market complacency reached new highs.

This week, financial markets have been dyed red and the stock market reaction adds to concerns about a possible impending recession.

The first thing we must understand is that we are not facing a panic created by a black swan, that is, an unexpected event, but by three factors that few could deny were evident:

Excessive valuations after $20 trillion of monetary expansion inflated most financial assets.
Bond yields rising as the US 10-year reaches 3.2%
The evidence of the Yuan devaluation, which is on its way to surpass 7 Yuan per US dollar.
Global growth estimates trimmed for the sixth time in as many months.

Therefore, the US rate hikes – announced repeatedly and incessantly for years – are not the cause, nor the alleged trade war. These are just symptoms, excuses to disguise a much more worrying illness.

What we are experiencing is the evidence of the saturation of excesses built around central banks’ loose policies and the famous “bubble of everything”. And therein lies the problem. After twenty trillion dollars of reckless monetary expansion, risk assets, from the safest to the most volatile, from the most liquid to the unquoted, have skyrocketed with disproportionate valuations.

(courtesy Incrementum AG)

Therefore, a dose of reality was needed. Monetary policy not only disguises the real risk of sovereign assets, but it also pushes the most cautious and prudent investor to take more risk for lower returns. It is no coincidence that this policy is called “financial repression“. Because that is what it does. It forces savers and investors to chase beta and some yield in the riskiest assets.

…click on the above link to read the rest of the article…

Spain: IMF Highlights Rising Risks

October 8, 2018

Spain: IMF Highlights Rising Risks

The International Monetary Fund can be criticized for many things, but its analysis of countries’ debt risk tends to be worth a read.

In this case, the International Monetary Fund has once again warned Spain of the risk of reversing reforms and increasing imbalances.

It asks to deepen in the labor reform to end structural unemployment and credible measures for the 2019 budget.

The IMF is often criticized on many sides. It is often accused of being “neoliberal” despite the fact that in almost all its recommendations aim to prevent spending cuts. It is wrongly criticized, on many occasions, for being negative on countries. It is exactly the opposite. The IMF is often too diplomatic and, above all, undemanding with governments.

A clearly diplomatic IMF has verified in its last report the important risks facing the Spanish economy. As growth slows down more quickly than expected, the risks that threaten the recovery have increased and many of the socialist government’s announcements could be counterproductive and accelerate a relapse.

In a very diplomatic but forceful way, the IMF warns about the governments’ optimistic and inflated estimates of tax revenues. No wonder, because the average error in revenue estimates for new taxes in Spain is very important, an average of 5.8 billion euro annually.

Inflated estimates are an easy trick to square budgets. Making impossible estimates of tax revenue while spending increases are very real. Then, when deficits soar, blame an external enemy.

The graph below shows the historical overestimation of tax revenues (5.8 billion euro per annum more tax revenues estimated than actually collected).

Spain: IMF Highlights Rising Risks

The Spanish Treasury Inspectors themselves have warned: “It would also be very interesting that those who speak again and again of these striking figures will provide the studies on which they are based to compare them. From previous unsubstantiated studies, inadequate and impossible proposals arise”(Tax Inspectors, January 2015).

…click on the above link to read the rest of the article…

The Synchronized Growth Fallacy (Interview at Real Vision)

October 4, 2018

The Synchronized Growth Fallacy (Interview at Real Vision)

Please find the complete interview here.

The fallacy of synchronized growth.

We have been hearing from international bodies, from central banks that we were living in a synchronized growth territory. That we were seeing developed markets grow faster than what was typical while emerging markets were also growing in tandem. And that
the economies were much healthier, that everything was much better, and that 2018 was a year in which we would see the confirmation of that synchronized growth trend and the reflation trade.

Well, it wasn’t the case. The case actually was that what we were being told was synchronized growth was actually synchronized debt growth. And that massive increase in debt that led to the highest level relative to GDP in history last year was creating massive problems, internal problems, in many economies that were getting used to cheap and easy money.

A very small, minuscule and completely moderate reduction in the balance sheet of the Federal Reserve of less than $260 billion, has created this reckoning. This reckoning that the reality that we were seeing globally was not a reality of higher growth, better
productivity, and more positive surprises. But the reality that it was just debt led bump up of a much clearer trend of secular stagnation.

So what happens is that we will likely see solutions that, instead of cleaning the system, will be solutions that will basically lead to more secular stagnation. Why?
Because what most central banks, what most governments will be doing, will be to try to avoid the pain. Avoid the pain of improving the economy.

What will they do then? What they will likely do is to perpetuate the problem via more demand-side policies. Therefore, this constant bailout of the less productive parts of the economies is actually more likely to be the “solution”.

…click on the above link to read the rest of the article…

Is The Oil Burden A Rising Problem?

September 23, 2018

Is The Oil Burden A Rising Problem?

While markets become increasingly bullish, oil prices are close to a “warning zone” where the barrel could be one -if not the only- catalyst of a major slowdown.

In my book “Escape from the Central Bank Trap”, I explain the concept of the “Oil Burden”. It is the percentage of global GDP spent on buying oil. It is often said that when the oil burden reaches 5-6% of GDP it can be a cause of a global slowdown.

The mistake that many make is to think that the oil burden is a cause and not a symptom.

In the past, we have seen that a period of abrupt increases in oil prices was followed by a recession or a crisis. However, not because oil prices rose rapidly, but because the dramatic increase in commodities’ prices was caused by a bubble of credit and excess monetary stimuli.

In reality, the oil burden is perfectly manageable at 5% of GDP because the energy intensity of GDP growth is diminishing. We are less dependent on energy to create growth in the economy.

Global energy intensity (total energy consumption per unit of GDP) declined by 1.2% in 2017, slightly below its historical yet unstoppable trend (-1.5%/year on average between 2000 and 2017 and -1.8% in 2016). In fact, global energy intensity is down 54% since 1990.

So the problem is not the oil burden by itself but the cause of the price spike.

When oil prices rise abruptly we should be concerned, because they can cause a domino effect on the real economy. When the reason for the price increase is not fundamental, we have a major problem.

Why are oil prices rising abnormally in recent months?

…click on the above link to read the rest of the article…

The Eurozone’s Coming Debt Crisis

June 13, 2018

The Eurozone’s Coming Debt Crisis

The European Central bank has signaled the end of its asset purchase program and a possible rate hike before 2019. After more than 2 trillion euro of purchases and zero interest rate policy, it is overdue.

The massive quantitative easing program has generated very significant imbalances and the risks outweigh the questionable benefits.

The balance sheet of the ECB is now more than 40% of the Eurozone GDP.

The governments of the Eurozone, however, have not prepared themselves at all for the end of stimuli.

Rather the contrary.

The Eurozone states often claim that deficits have been reduced and risks contained. However, closer scrutiny shows that the bulk of deficit reductions came from lower cost of debt. Eurozone government spending has barely fallen, despite lower unemployment and rising tax revenues. Structural deficits remain stubborn, and in some cases, unchanged from 2013 levels.

The 19 eurozone countries have collectively saved 1.15 trillion euros in interest payments since 2008 due to ECB rate cuts and monetary policy interventions, according to Handelsblatt. A reduction in costs against the losses of pensioners and savers.

However, that illusion of savings and budget stability can rapidly disappear as most Eurozone countries face massive maturities in the 2018-2020 period and wasted precious years of quantitative easing without implementing strong structural reforms. Tax wedge rose for families and SMEs, while current spending by governments barely fell, competitiveness remained poor and a massive one trillion euro in non-performing loans raised doubts about the health of the European financial system.

The main eurozone economies face more than 2.1 trillion euro in maturities between 2018 and 2021. This, added to lower tax revenues due to the slowdown and rising spending from populist demands creates an enormous risk of a large debt crisis that no central bank will be able to contain. Absent of structural reforms, the eurozone faces a Japan-style stagnation or a debt crisis.

…click on the above link to read the rest of the article…

After Italy… Spain Risk Soars

June 1, 2018

After Italy… Spain Risk Soars

Political risk in Europe was largely ignored in international markets because of the mirage of the so-called “Macron effect”. The ECB’s massive quantitative easing program and a perception that everything was different this time in Europe added to the illusion of growth and stability.

However, a storm was brewing and the same old problems seen throughout the years in Europe were increasing.

In Italy, the shock came with an election that brought a coalition of extreme left and extreme right populists. Disillusion with the Euro was evident in Italy for years, as the economy continued to be in stagnation while debt soared. However, international bodies, mainstream analysts, and banks preferred to ignore the risk, instead continuing to announce impossible growth estimates for the following year and science-fiction banks’ profitability improvements.

Italy’s economic problems are self-inflicted, not due to the Euro. Governments of all ideologies have consistently promoted inefficient dinosaur “national champions” and state-owned semi-ministerial corporations at the expense of small and medium enterprises, competitiveness and growth, labor market rigidities created high unemployment, while banks were incentivized to lend to obsolete and indebted state-owned companies in their disastrous empire-building acquisitions, inefficient municipalities, as well as finance bloated local and national government spending. This led to the highest Non-Performing Loan figure in Europe.

Now, the new government wants to solve a problem of high government intervention with more government intervention. The measures outlined would imply an additional deficit of some €130bn by 2020 and shoot the 2020 Deficit/GDP to 8%, according to Fidentiis.

Italy’s large debt and non-performing loans can create a much bigger problem than Greece for the EU. Because this time, the ECB has no tools to manage it. With liquidity at all-time highs and bond yields at all-time lows, there is nothing that can be done from a monetary policy perspective to contain a political crisis.

…click on the above link to read the rest of the article…

Forget the Yuan: King Dollar is Here to Stay

February 27, 2018

Forget the Yuan: King Dollar is Here to Stay

Many believe deficit spending will kill the US dollar as a reserve currency and the yuan will take over. They are wrong.

Economist Daniel Lacalle asks Can China Really Kill The US Dollar Supremacy?

>Why China Will Fail to Dethrone the US Dollar

First, because it wants the world to widely accept the Yuan while maintaining monetary repression via capital controls. As the British say, they want to “bake the cake and eat it.” What kind of global reserve can be created when capital controls are imposed? None. No economic agent will accept it.

Second, because most economic agents are aware that the huge imbalances of the Chinese economy will likely be disguised with a huge devaluation. The average of estimates assumes between an 18% and a 20% additional devaluation against its main trading currencies in the next five years. The more this inevitable correction is delayed, the less the possibility of reinforcing the credibility of the yuan as a world reserve currency.

Third, the financial balance is against them. The reason why China maintains completely obsolete capital controls is that domestic economic agents, as soon as markets open, do everything possible to get rid of their yuan in the face of the evidence of a huge devaluation. That is why China has lost almost one-third of its reserves in foreign currency in a few years.

The only way in which China and Russia could pose a threat to the US dollar would be to defend sound money and end the disastrous monetary policy that governments are conducting. A commitment to a return to a gold standard and avoid massive money supply increases. However, that does not seem to be the case, rather to spread China’s monetary imbalances to the rest of the world.

…click on the above link to read the rest of the article…

Is There a Way Out of the ECB’s Trap?

November 15, 2017

IS THERE ANY WAY OUT OF THE ECB’S TRAP?

The ECB faces the Devil’s Alternative that Frederick Forsyth mentioned in one of his books. All options are potentially riskly. Mario Draghi knows that maintaining the so-called stimuli involves more risks than benefits, but also knows that eliminating them could make the eurozone deck of cards collapse.

Despite the massive injection of liquidity, he knows that he can not disguise political risks such as the secessionist coup in Catalonia. The Ibex reflects this, making it clear that the European Central Bank does not print prosperity, it only puts a floor to valuations.

The ECB wants a weak euro. But it is a game of juggling to pretend a weak euro and at the same time a strong economy. The European Union countries export mostly to themselves. Member countries sell more than two-thirds of their goods and services to other countries in the eurozone. Therefore, the more they export and their economies recover, the stronger the euro, and with it, the risk of losing competitiveness. The ECB has tried to break the euro strength with dovish messages, but it has not worked until political risk reappeared. With the German elections and the prospect of a weak coalition, the results of the Austrian elections and the situation in Spain, market operators have realized – at last – that the mirage of “this time is different “in the European Union was simply that, a mirage.

A weak euro has not helped the EU to export more abroad. Non-EU exports from the member countries have been stagnant since the monetary stimulus program was launched, even though the euro is much weaker than its basket of currencies compared to when the stimulus program began. The Central Bank Trap, which I explain in my new book.

…click on the above link to read the rest of the article…

Is There Any Way Out of the ECB’s Trap?

November 10, 2017

Is There Any Way Out of the ECB’s Trap?

…click on the above link to read the rest of the article…

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