After a couple of weeks away from the screens, I’m back… However like Jack Torrance from the famous Kubrick movie The Shinning, I feel like I am seeing things.
It is one thing for short term rates to be pushed to negative yields, but on Friday the German 5 year note ticked below zero!
For the privilege of having Germany hold your money for five years, you get exactly zero return. Think about that for a second. Five years with a zero return. I would have never guessed that a major bond curve could negative that far out.
In a stunning development, the German yield curve now trades right in line with the Japanese curve.
The Japanification of Europe seems to be finally complete.
I know that this morning there are renewed worries about a Greece exit from the European Union that are stressing markets. But this development is not the cause of the problem, merely a symptom.
I have long held the belief that the ECB’s policies are simply too tight. The ECB’s two biggest rivals, the Federal Reserve and the Bank of Japan, have been expanding their balance sheet at an astonishing pace. During this same period, the ECB has allowed their balance sheet to contract by more than a third.
The ECB’s relative tightness has meant that Europe has imported all of the Japanese and US deflation. There are obviously many more factors affecting the various global economies, but at its root, the ECB’s unwillingness to match the Fed and Bank of Japan’s expansion has doomed Europe to a moribund economy.
In this age of over indebtedness at almost every level, there is a desperate need of every little sliver of growth. Without growth it is very easy for economies to slip into a “balance sheet recession.” This is what Japan experienced during the 2000s, and it is what Europe is now mired in.
As the overhang of the debt becomes larger in real terms as growth remains elusive and inflation turns into deflation, the ability of the European economy to steer out of this slump becomes increasingly difficult.
When you throw into this mix the political impediments of the ECB executing a proper balance sheet expansion, it is difficult to see how the European Union is going to survive in its present form.
Although the markets are hopeful that Draghi will be able to deliver an effective QE program at the next ECB meeting, I fear we might be past the point of saving the European Union.
Deflation is raging throughout the world. Things are breaking everywhere you look. There is an increasing desperation on the part of many governments.
Half measures from the fractured ECB are not going to cut it any more. Today it is the Greeks, but how soon before the Italians or the French realize that allowing the German hard money policy to doom them to importing the rest of the world’s deflation?
This week-end the Germans signalled that they were prepared to let Greece exit the Union as they were not “systematically important.” Merkel claims that fallout will be contained. This rings very similar to Bernanke’s claim that the real estate credit problems in 2006/7 were also contained. Even if Merkel is correct that there won’t be a financial crisis from a Greece exit, I am of the opinion that Greek economy will improve on an exit. It won’t be long before other countries realize that leaving the EU earlier has a big first mover advantage.
The German insistence on austerity and relative Central Bank tightness is going to lead to the break up of the European Union. They have convinced themselves that they can handle the consequences. I just wonder how many BMWs they will be selling when the new Deutsche Mark doubles or triples in value after the EU falls apart.