There’s an undeniable growing amount of economic data -not just in the U.S- indicating the global recession is spreading. This despite the best efforts of central banks. Currency printing presses are running at a near-frenzy pace, yet aggregate demand seems virtually unaffected. As I wrote 2 years ago (www.noQE3.com) QE has the reached the point of diminishing returns and has become as productive as pushing on a string. Yet the U.S., Japan, and the U.K., are busy weakening their currencies. Hopes are high that the ECB will actually fire-up the printing press this summer, not merely threaten to do something (what ever it takes!) like last summer — though I point out Dr. Draghi’s famous threat managed to do a great deal for risk-on speculators in the equity market. Sorry bond market speculators. You got crushed if you applied risk analysis to peripheral European sovereign bonds. You made a killing if you were bet heavily on the trashiest of assets.
Back to the ECB. Since it isn’t actively debasing the euro, international competitiveness of european exports (read as heavily German) are going to find it increasingly tough. The German economy is likely to fall deeper into recession as 2013 unfolds. So bad (economic) news will be good news– for stock market risk-on speculators right? The logic being that bad economic news will make it more likely the ECB will begin debasing the euro in parallel with other large central banks.
Here’s the trouble with that point of view: it underestimates German fear/hatred of inflation. German central bankers are fervent opponents of inflationary monetary policy for reasons that are well known (hyper inflation of 1920-1923). In addition, look at Europe from the point of view of fiscal soundness. It’s a disaster — debt/GDP ratios are unsustainable, and there is a lack of political will to apply responsible budget policy. The icing on the cake is the terrible demographics. The European poster child for bad demographics and monstrous debt — take Italy for example. Enrico Letta has just been appointed Prime Minister of a coalition parliament. He has not been in the job 24 hours and has already announced intentions to reverse austerity plans. This is not going to go over well in Berlin and Frankfurt (and Brussels). Why any ECB member would vote to keep buying Italian -or anyone’s- sovereign bonds when there is no demonstrated will to implement responsible budget plans is beyond me.
I grant that the ECB might announce another 25 basis point cut in short term interest rates. That might stoke a small risk-on rally for a few hours or days, but it will be a pointless exercise. If there’s no demand for money when short term interest rates are 0.75%, what difference will it make if you drop it to 0.50%?
Germans head to the polls in September. I don’t see the ECB provoking Germans -via any inflationary QE efforts- until after their election. A new political party is gaining traction in Germany. Its platform: anti-EU. It’s a long-shot in terms of wining seats, but it could easily cause a groundswell of euro-skepticism causing populist political leaders with a legitimate prospect of wining to adopt similar views.
The ECB is going to have to wait a respectable amount of time after the German election (a month?) before it seriously considers dusting off the euro printing press. By November, the prospects of heavy year-end bond re-financing is going to come into view and the pressure will mount. It’s going to be an interesting year.