October 26, 2015
Even at these historically low rates, don’t fix your mortgage. Interest rates are going lower. Renegotiate now if you can! Don’t take my word for it: listen to Mario Draghi.
The chief bottle washer of the ECB is worried, so worried in fact that he’s ready to print more money on top of the €1.1tn he’s already minted in the past year, in order to kick start the European economy. Interest rates in Europe fell again yesterday , not because Enda claimed that the Oglaigh na h’Eireann were ready to do some Latin American Junta-style head-kicking at the ATMs if the Euro money ran out, but because Draghi said he’d cut rates again.
On the face of it, Enda’s fear of widespread Euro-related unrest in 2011/12 and Mario’s fear of Euro-related deflation now seem unrelated. But they are not. They are inextricably linked. In truth, they are two sides of the same coin.
Despite the fact that the Euro seems much safer now and its existence is not immediately threatened, the underlying problems that nearly tore the Euro asunder, haven’t gone away. Indeed, you could argue that the problem has worsened, but they just have been masked by the ECB willingness to buy every IOU issued by every European government.
Back in 2011, the ECB was run by Mr Trichet who showed no understanding of either the severity of the crisis or the role of the central bank in easing it. As investors stopped lending to Eurozone governments, someone or some bank had to step in and lend – and that institution had to be the ECB.
As the crisis became more acute, Trichet was replaced by the pragmatic Draghi , who tore up the rule book and did what all Italians do in a crisis – he printed money.
This move caused all bond rates to fall because the ECB was now the buyer of last resort for everyone and everything. Falling bond rates are supposed to signal that risk has fallen, but is this actually the case in Europe?
Have the underlying factors that caused the 2011 Euro crisis actually dissipated or do they lurk under the surface?
Ironically, the Eurozone back then and still now, is faced with what could be described as a Trokia of problems – (1) not enough growth, (2) too much debt and (3) no political leadership.
It is now nearly four years since Draghi said he would do “whatever it takes” to save the Euro but still none of the fundamental problems have been solved. All the money printing hasn’t kick-started the Eurozone economy; rather than causing growth and inflation, the Eurozone is now facing deflation.
This deflation is leading to panic because the solution to too much debt is inflation not deflation. For the past four years, the ECB has got its inflation forecasts wrong, yes wrong. But in the unaccountable world of central banking, failure is rewarded and getting forecasts wrong doesn’t seem to matter.
Europe’s economy isn’t growing and it isn’t investing. The money that the ECB is printing is not going into productive investing which delivers growth. Instead, it is driving up asset prices, fueling financial speculation by the rich, which is causing greater inequality.
But why isn’t the European economy growing? Why aren’t European companies – some of whom have never been more profitable – investing right now?
This is where we have to go global to explain things.
While the average European mightn’t travel too much and especially not outside Europe, corporate Europe is hyper-global. Its worldwide footprint makes it highly sensitive to the global economy and the reluctance of Europe’s biggest companies to invest is a function of global conversations at board level.
Those conversations will start with the observation that demand in Europe is still very weak. America may be growing but is that enough when Japan hasn’t been right for a generation and the Chinese economy is facing a rapid post-boom contraction? Elsewhere, the big commodity-based emerging markets like Brazil, South Africa and Russia are simply derivatives of China as their wealth is largely a function of China’s demand for their raw materials.
So global aggregate demand is too soft to justify new large-scale investment. There isn’t enough aggregate demand in the rest of the world to make large corporations commit to investment. Remember that real investment tends to be in big machines that make big stuff.
This lack of demand is unfortunately coincident with a massive glut of supply. There’s over-capacity everywhere, particularly in China. Five years of hyper-investment in China has led to over-capacity in almost every major industry. How else can you explain slumping commodity prices and deflationary pressures everywhere?
Against such a background, can you imagine what would happen to the career prospects of a French steel executive who suggests to the CEO that they build a massive new plant to export steel to China?
The short-term implication of the Chinese investment boom is far too much supply in the global economy. All the heavy equipment that the world needs is already in China and this will take quite a while to use up. Corporate Europe faces a global supply chain – not a national supply chain – too much capacity in China actually means too much capacity in Europe. As a result, it would be wrong to expect a material pick-up in large-scale Europe business investment.
Without investment, income can’t rise.
When investment increases, demand increases, driving up wages and income. Ultimately, where do savings come from? Savings come from income, of course! Income is the font of savings. Without income you can’t possibly have savings and without investment you can’t raise income in any material way.
Therefore the ECB is stuck. It has used all its bullets and the problems haven’t gone away. Debts are still enormous, as deflation stalks, it becomes more difficult for people, governments and companies to pay their debts, because they can’t raise their prices or wages to cover their interest payments. So all the central bank can do is keep rates at zero for as long as it can.
This is what is happening, which is why you’d be mad to fix your mortgage just yet!