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.
(Click on the image to watch me and Rick Santelli discuss the ECB/Bundesbank conundrum.)
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.
December 27, 2016 at 10:17 pm |
You’re Late!! …or just too modest.
I already prominently featured your latest Santelli Exchange discussion in Thursday morning’s http://www.rohr-blog.com post. Always such enlightened stuff, and thanks for the further dissection in today’s update.
Y’know, after over 30 years of definitive insights on how the central bankers think/operate you still manage to keep it fresh.
Thanks and Happy New Year pal.
December 28, 2016 at 3:57 am |
Yra- Excellent analysis.
Re Dow 20,000, it will hit this meaningless number and make headlines while observers will shout “whoop-pee” as they pour champagne over each other. But I remember when the Dow first hit 1000 in November 1972 and the event was marked on the front pages of the NY Times and most other papers. Within a couple of months it began a descent for the biggest bear market at the time since 1929. The Dow lost 40% of its value by 1974.
Re Germany. They are between a rock and a hard place. They either have to continue being the ECB ATM machine and have their honestly earned surplus sent to the “all it takes” general, who buys bankrupt sovereign debt at mispriced levels, or says they will no longer participate in this game of make believe and say the cash machine is closed. In that case the house of cards collapses and Germany’s exports fall off the cliff.
As you point out the 800 pound gorilla is the massive global debt that has been sustained by ZIRP and NIRP and now or whenever interest rates return to normal levels, Dow 20,000 and all the other asset inflated areas will collapse with it. The Euro will disappear and historians will look back at the Maastricht Treaty in the same way we view the Treaty of Versailles today.
December 28, 2016 at 8:38 am |
as always, Rohrinter and Asherz provide interesting worthwhile additions to the Underground’s Notes. This (Notes) was a perfect read.
Bonfire of Vanity indeed! When the vanity of two powers collides, what will be the outcome? Will it be a marriage of Medicis or a Hatfields vs McCoys? In either case there will be a price to be paid in Europe.
Since Brexit, is it fair to think that, let’s say I’m Ireland, and when the piper must be paid – as in when interest rates rise, the gargantuan ship of fools that is the bond holdings of EU takes on water of declining value/asset value – individual sovereign states will just say: “we’re outta here. This mess belongs to someone else because we are OK”? What then? The Rotten Heart will own a pile of declining valued assets and those who owe the most interest and principle will not be able to pay. Heart attack?
Looking forward to my mind being challenged and the entertainment of “Notes from the Underground” and its provoking, thoughtful readers in 2017.
December 28, 2016 at 3:00 pm |
Ready. “Volatility is the key to wealth.” YH
December 29, 2016 at 2:00 pm |
“Knowledge Brings Fear” Professor Farnsworth
December 29, 2016 at 4:53 am |
Following your argument via Steinhardt’s four rules:
1. The trade/idea: real estate in Germany
2. The consensus view: ECB, euro status quo
3. The “variant perception” (contrarian view): D-mark come back
4. Trigger event: German elections, October 2017
December 29, 2016 at 9:04 am |
Yra thanks for your 2 Deutsche marks worth. What would be the vehicle for redistributing the German account surplus? Does the monetary union have a taxing power or would the German government tax the surplus and redistribute to the poorer nations. Being half German, I can’t imagine the people of Germany tolerating either. Another good investment may be a futures bet at Ladbrokes on Merkel’s defeat.
December 29, 2016 at 10:17 am |
bigman—the EU has no taxing power which is why I continue to ask –who and what guarantees the ECB balance sheet–and of course FOMC Governor Powell directly answered my query with—“they have a printing press”
December 31, 2016 at 12:28 am |
bigman, Bernard Connolly, from 15:10, answers your question https://www.youtube.com/watch?v=NhKIqt_SIFg
January 1, 2017 at 1:03 pm
thanks Cris With interest rates controlled by Draghi, a single currency printed by the ECB and an open market with no tariffs there is no mechanism to balance the current account surplus in Germany Germany definitely benefits from the weak euro. Bernard Connolly states to achieve balance would require 10% of Germany’s GDP transferred to the poorer countries and for these countries to use the funds in a way that decreases the imbalance- good luck. too bad Frederick Hayek isn’t around to see this triumph of central planning.
January 2, 2017 at 12:45 am |
bigman and Cris—-citing Bernard Connolly elevates this discussion in very important wyas–thanks for the additional adds and A bIGMAN SAYS —perpetual transfers are cited by Bernard Connolly as being a major component of the potential failure of the EU project.Well done ,both of you.
December 29, 2016 at 1:37 pm |
Toshiba – Trades similarly to gold or a TBTF institution in perpetual bailout.
December 31, 2016 at 8:34 am |
Why 2017 Could See the Collapse of the Euro
Joseph E. Stiglitz
http://fortune.com/2016/12/30/euro-outlook-2017/
December 31, 2016 at 3:05 pm |
Expect the unexpected, maximum tediousness.
January 1, 2017 at 9:28 am |
[…] paying attention to Germany. Angela Merkel is up for election in October of 2016. My friend Yra Harris pointed out that there is a bureaucratic war going on between the ECB and the Bundesbank. Because […]
January 4, 2017 at 10:45 am |
Traveling Spain. “Drop in Spanish jobless total is biggest on record” (FT)
https://www.ft.com/content/f673c81c-d27d-11e6-b06b-680c49b4b4c0#comments
January 4, 2017 at 7:15 pm |
Arthur–I saw this but would need to see three in a row to be convinced and besides Draghi may see but he is not concerned
January 5, 2017 at 12:26 pm |
is Trump’s plan of keeping jobs (auto industry specifically), in USA counter-intuitive to the Law of Comparative Advantage?” Keeping manufacturing jobs away from say, Mexico and moving back to USA may eventually hurt in long run here? Thank.
January 5, 2017 at 2:43 pm |
david—in a world of perfect free market the assumption that Adam Smith makes is correct.Takes me back to ECON 101 with the six elements of free markets but of course they only exist in an economic model and so that is why this blog tries to look at the world of political economy—-thus 2+2=5 and I am not meaning to be a wise guy
January 5, 2017 at 3:06 pm |
The manufacturing jobs delusion (The economist)
http://www.economist.com/blogs/buttonwood/2017/01/economics-and-finance
January 5, 2017 at 8:07 pm
Open and shut case.
http://www.cjr.org/the_audit/bw_oversells_its_story_on_amer.php
January 20, 2017 at 8:45 am |
[…] Despite the rally in the stock market, there are undercurrents in the economy that are very troubling. While waters on the surface seem calm, a lot of us see below them and don’t like what we see. […]
April 12, 2017 at 8:38 pm |
[…] am relinking the Santelli/Harris CNBC spot from December 27. It’s very relevant for all of the discussion taking place about […]
May 22, 2017 at 5:20 pm |
[…] For several months I have warned against being LONG DOLLARS and SHORT EUROS after the French elections as a EURO RALLY would benefit Frau Merkel as she headed into the election. It has been the task of Finance Minister Schaeuble to attack President Draghi while Merkel remained silent. Merkel’s statement today reflects a change in tactics with four months until the German elections. Last week’s CDU victory in North Rhine-Westphalia was a huge upset as the Social Democrats had governed the state for 46 of the past 51 years. The Chancellor has a political tailwind in which she may hope to garner and absolute Parliamentary majority and rule without a coalition. This is, of course conjecture, outside conventional wisdom but if ANGIE can successfully attack the ECB she can say goodbye to the SPD and the Free Democrats. Also, a Merkel attack on the ECB may retrieve some disenchanted voters from the AfD. It seems that the Chancellor is in the arms of two Italians: Mario Draghi and Niccolo Machiavelli. As Mick Jagger would sing: “Angie your kisses still taste sweet.” […]