Category Archives: Europe

Europe

A Euro Nightmare for the European Central Bank (The Epoch Times)

Europe

Article published originally here.

The primary purposes of the incorrectly named “unconventional monetary policies” are to debase the currency, stoke inflation, and make exports more competitive. Printing money aims to solve structural imbalances by making currencies weaker.

In this race to zero in global currency wars, central banks today are “printing” more than $200 billion per month despite that the financial crisis passed a long time ago.

Currency wars are those that no one admits to waging, but everyone wants to fight in secret. The goal is to promote exports at the expense of trading partners.

Reality shows currency wars do not work, as imports become more expensive and other open economies become more competitive through technology. But central banks still like weak currencies—they help to avoid hard reform choices and create a transfer of wealth from savers to debtors.

So how must the bureaucrats at the European Central Bank (ECB) feel when they see the euro rise against the U.S. dollar and all its main trading currencies by more than 12 percent in a year, despite all the talk about more easing? The ECB will keep buying 60 billion euro a month in bonds, maintain its zero interest-rate policy, and keep this “stimulus” as long as it takes, until inflation growth and GDP growth are stable.

Contrary to the wishes of the ECB, however, a strong euro is justified for several reasons. First, the European Union’s trade surplus is at record highs, and 75 percent of Eurozone trade happens between Eurozone countries. Higher exports and the continued recovery of internal demand in European member countries strengthen the euro.

The third is the perception of weakness of the U.S. government and its inability to push through key reforms. This has weakened the dollar and by definition strengthened the other two large trading currencies, the euro and the Japanese yen.The second important factor is the relief rally after the French and Dutch elections. The fears of a Euro breakup have been eliminated, or at least delayed, as pro-EU political parties won.

The Problems With a Strong Euro

However, a strong euro has very significant implications for the EU economy and the ECB’s policy.

The strong euro puts exports to its main outside trading partners, the United States (20.8 percent of exports in 2016) and China (9.7 percent), at risk. Despite the ECB’s extreme monetary policy and a euro trading almost at parity with the dollar, exports to non-EU countries have stalled since 2013. GDP growth estimates for 2018 are falling due to a lower contribution of net exports.

The currency also has a high impact on tax revenues in Europe. The correlation between the euro–dollar exchange rate and the earnings estimates of the largest multinationals represented in the Stoxx Europe 600 Index is very high.

According to our estimates, a 10 percent rise of the euro against the dollar is equivalent to an 8 percent drop in earnings and leads to lower corporate tax revenues. From an investment perspective, as earnings drop, the European stock market goes from being relatively cheaper to becoming more expensive.

Investors and economists need to pay attention to these factors. If the euro continues to strengthen, the EU economic recovery is at risk. So the Eurozone is stuck between a rock and a hard place. It cannot stop the stimulus because deficit spending governments cannot live with higher financing costs, and increasing the stimulus to weaken the currency simply doesn’t work anymore.

The only way out is structural reforms, but most governments are afraid of them even in good times, let alone when the going gets tough.

Daniel Lacalle is chief economist at investment management company Tressis and author of the recent book “Escape from the Central Bank Trap” (published by BEP).

Courtesy of The Epoch Times. Read here.

How will the Fed reduce its balance sheet & and how will the ECB end QE? – 18 economic experts weigh in (Focus Economics)

Europe, Global Economy, On the cover, Sin categoría

I believe this is a truly excellent article explaining expansionary monetary policies and outlining the possibilities of unwinding quantitative easing programs. Eighteen global leading economists share their opinions.

Please read all the comments at Focus Economics here.

My part:

“The Federal Reserve is already seriously behind the curve. Reducing the balance sheet by $600bn after a $4.7 trillion stimulus and delaying rate hikes simply make the problem more difficult to solve as we approach a change of cycle and the central bank finds itself with fewer tools. The Federal Reserve should take advantage of the unprecedented demand for USD and the fact that macro drivers and corporate profits are improving to accelerate its unwinding of the stimulus. However, it seems comfortable ignoring the risks of perpetuating bubbles in financial assets. By being too focused on financial markets it becomes what I call in my book “Escape from the Central Bank Trap” a “pyromaniac firefighter” that creates a massive bubble and presents itself as the solution when it bursts. 

The Federal Reserve could be raising rates and unwinding its balance sheet by $50-100bn every month now that demand for bonds and equities remains solid and the employment, inflation and growth data is improving, while earnings estimates are increasing. There would be more than ample secondary market demand for a solid sterilization program.

The ECB is caught between a rock and a hard place. It is on its way to reaching a balance sheet size of more tan 25% of GDP of the Eurozone and inflation expectations are falling, unemployment and slack are still high, proving that the problem of the Eurozone was never of liquidity and low rates. When the ECB QE started, excess liquidity was c€185bn and today it is close to €1.3 trillion. In the process, highly indebted and deficit-spending countries saved billions in interest payments,… but their imbalances remain and they have spent those savings and more, making it almost impossible for the ECB to taper and raise rates because high-deficit countries would be unable to assume it. But at the same time, the overcapacity of the economy is perpetuated and many countries are calling for further spending increases and widening deficits. The ECB, therefore, needs to give a stronger message to governments so that they accelerate reforms to reduce excess spending and improve growth, lower taxes. If the ECB starts a sterilization program and manages long-term rates adequately, it could successfully promote structural reforms, help spur growth and use that massive excess liquidity to keep bond yields low while governments improve their fiscal position. This would reduce the perverse incentives that some may have to increase imbalances just because QE is there. Furthermore, as the crisis is way behind us, the ECB’s purchases would be easily offset by real investor demand, as fundamentals improve. There is still time before Europe enters a dangerous “Japanization” process.”

Courtesy Focus Economics. Follow @FocusEconomics

Daniel Lacalle is Chief Economist at Tressis SV, has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)

See more at: https://www.dlacalle.com/what-does-dr-copper-tell-us-about-global-growth/#sthash.AmZP9FEL.dpuf