It seems that Janet Yellen and Angela Merkel are both under attack for offering to provide shelter. Yellen, for offering to shelter investors, and Chancellor Merkel refugees from war-torn countries. Chair Yellen has sparked a heated discussion about the possibility of negative rates in the U.S. as the Fed tries, yet again, to provide a calm port for debtors being tossed about by the lack of any inflation to relieve the burdens of too much debt. Nothing like a good currency debasement to ease the pressure of debt on a society’s balance sheets. The longer the central banks repress savers without igniting the flames of inflation the more detrimental the ZIRP and possibly NIRP (negative interest rate policy). If savers are receiving nothing on their earnings and inflation is not providing debt relief, the entire financial system seems to stagnate and that is apparently what is happening worldwide. This is the ultimate liquidity trap and the fear of central banks having no answers is at the top of the list of investor concerns. I warned about this possible outcome for many years and now it seems the possibility is becoming reality.
Complicating the situation for the ECB and Mario Draghi is the fact that German Chancellor Merkel has overextended her popularity by accepting a massive amount of refugees into Germany. This has aroused the anger of an electorate suffering under the burden of being the creditor for the entire EU project. Negative interest rates have financially repressed the middle class German savers and also wreaked havoc on German banks, pension funds and insurance companies. There are regional elections in Germany in mid-March and the results will be important to see how unpopular Chancellor Merkel has become and whether it is the AfD (Party for Deutschland) that has garnered renewed support. Again, President Draghi needs the strength of Angela Merkel to defend the ECB‘s policies against the criticism from the German hard-money crowd and especially Bundesbank President Jens Weidmann.
In today’s London Telegraph, there is an important column by Ambrose Evans-Pritchard titled, “German ‘Bail-In’ Plan For Government Bonds Risks Blowing Up the Euro.” Evans-Pritchard cites one of the five wise men of the German Council of Economic Advisers, Peter Bofinger, who suggests a new German plan to “… impose ‘haircuts’ on holders of eurozone sovereign debt risks….” This is an issue I’ve discussed over the years in this blog for currently under BIS regulations all sovereign debt carries a ZERO RISK WEIGHTING. Evans-Pritchard continues to write: “The German Council has called for a ‘sovereign solvency mechanism’ even though this overturns the financial principles of the post-war order in Europe, deeming such a move necessary to restore the credibility of the ‘no-bailout clause in the Maastricht Treaty.” Professor Bofinger is opposed to such a plan for it will of course ignite a bond and banking crisis across Europe as financial institutions are forced to raise even more capital because of the proscribed haircuts.
Any country that is subject to a “haircut risk” will see its debt sold by banks that do not want to be in a situation of having to raise even more capital in an already debt-stressed market. Professor Bofinger is adamant that the German Council is being very shortsighted and will create “… a self-fulfilling all too quickly, setting off a ‘bond-run’ as investors dump their holding to avoid a haircut.” As Evans-Prtichard warns, “The plan has the backing of the Bundesbank and most recently the German finance minister, Wolfgang Schauble, who usually succeeds in imposing his will in the eurozone. Sensitive talks are under way in key European capitals, causing shudders in Rome, Madrid and Lisbon.”
THIS PIECE BY EVANS-PRITCHARD IS VERY SERIOUS AND NEEDS TO BE WATCHED. Follow the European sovereign debt markets even though the pricing and signaling mechanism have been badly harmed by the ECB. If the Germans hold sway, Draghi’s whatever it takes to preserve the EURO will be retested and at -30 basis points and 60 BILLION EUROS OF QE A MONTH it will be a rough starting point for Draghi. A weakened Merkel has exposed a Mario Draghi under siege from a scorned Bundesbank. Merkel to Mario: Come in for shelter from the storm?
***As previously noted, yields on some of European sovereign debt have already begun to rise. Portuguese two-year yields have increased 150 basis points in the past month and Greek two-year yields reached 15% last week. This is reflecting new stresses in the sovereign bond markets but more important will be the yields on Spanish and Italian two-year notes.
***Quick history lesson: Today on the electronic media there was discussion of Chinese citizens sneaking money out of China by wrapping it around their bodies. It wasn’t long ago that Chinese smugglers would use TAELS, gold ribbons crafted by metal smiths that enabled one smuggling gold to wrap it in ribbon form around various parts of the body. So maybe rather than currency we will see a move to use gold as the item of choice.
***I’m Going to enjoy a few days of R&R but will be watching the world as there’s so much going on. Look back at the “Spark to Start a Prairie Fire” post because its relevance increases everyday (sadly to say). Be patient and keep your losses manageable and live to invest another day.