Every step I take, every move I make, I’ll be watching the DOW hit 20,000. As I’ve said before, it is insignificant as we enter 2017, the year of political uncertainty with massive amounts of global debt. The Financial Times published an article today titled, “6.6 Trillion of Debt Issuance, Borrowing Levels Beat 2006 Mark.” The world has been taking advantage of the ultra-low borrowing rates that the ECB, BOJ, BOE and the Fed have so thoughtfully accommodated the global financial system. Corporates and sovereigns have been issuers while pension funds, insurance companies and central banks have been buyers of the poorly valued risk. If U.S. rates actually sustain a rise in yields, the headwinds from bloated balance sheets will hampered the slow-growth global economy. This will be a theme that is far more important than the slow grind of the U.S. legislative process, which will impede the Trump express. The Democrats will fight rearguard actions to prevent Trump’s plans for tax cuts and deregulation from coming to fruition.
But the balance sheet recession plaguing Europe, China and the U.S. will increase the weight of interest payments, even in a zero rate environment. The KEY to Europe will be the battle between the ECB and the interests of the Bundesbank. The ECB’s balance sheet is loaded with the sovereign debt of weak borrowing STATES, but in the realm of central bank rules it is all weighted the same. Yet someone has to guarantee the SOVEREIGN DEBT for it all to carry a similar risk weight. This is fine as long as the Germans are willing participants. But In October 2017 the German elections are front and center. So the issue of who guarantees the ECB’s balance sheet will be a key in Chancellor Merkel’s quest for a fourth term. The German policymakers will have to make a determination whether the German populace will provide the wherewithal for a perpetual TRANSFER UNION, sending its current account surplus to the poorer nations of Europe.
To illustrate and explain the situation: When the euro launched in 1999, the German D-mark was 1.66 to the U.S. dollar and its CURRENT ACCOUNT was in deficit. Today, the D-Mark has an equivalent value to the DOLLAR of 1.87 and the German current account surplus was $285 billion, or 8.5% of GDP in 2015, far greater than China’s. In a non-euro world the D-mark would be appreciating in an effort to correct the massive surplus. Since Germany is unable to appreciate the euro against its largest trading partners, it means the SURPLUS will continue to grow. It is this issue that plagues the European Union. The end-game is either for Germany to leave the EURO and REVALUE or the Bundestag will be a redistributor of German wealth by transferring its current account surplus to the less fortunate states of the EU.
This is the question for Europe in 2017. Will the rest of Europe surrender their SOVEREIGNTY in an effort to harmonize fiscal policy and create an EU-wide Treasury? And what will the Germans ask of their European brethren in return for the massive transfer of wealth? The issue of immigration is merely a spark that fires the populace support of the Alternative for Deustchland (AfD) party. The key issue will be the ECB balance sheet or what will become the bonfire of the vanities. The central bank’s rush to build up its balance sheet in an attempt to trap Germany may be the greatest vanity of the last few decades–at least.
A response to a query from a very astute global-macro investor. If the scenario I put forward has merit: Where would be the best place to invest in Europe? My unequivocal answer is Germany. Real estate in Germany–if it hasn’t appreciated too much already–OUGHT to be a solid investment–for if Germany capitulates to Draghi’s design then inflation within Germany will increase. I refer back my analysis on the D-mark at today’s levels. If the EU maintains the status quo the virtual German currency is undervalued by all economic fundamentals unless the EU is deemed a perpetual transfer union. But if Germany would vacate the EU project due to political change Germany will be in far better shape than its massive indebted EU brothers.
For non-hard asset buyers the EWG, an ETF based on a pool of top German corporations becomes an important vehicle to watch for as an indication of Germany’s response to the ECB’s financial designs. Do your technical homework and find the risk levels that work for you. This year promises to be full of political and central bank intrigue. Trump’s honeymoon is not registered in Europe.