STAFF NEWS & ANALYSIS
EU Easing to Infinity and Beyond?
By Staff News & Analysis - November 12, 2013

Reports of the survival of the eurozone may have been greatly exaggerated … Last week's surprise interest rate cut by the European Central Bank (ECB) may have been taken as good news by the markets, but it was largely a response to the looming danger of deflation in the eurozone. And that is not good news at all. It is a severe problem of economic forecasting that if you manage to identify a major force that is going to have significant effects, you are rarely able to see quite when these will occur. You can give up, retire or die before the forecast events finally come to pass. The long-running crisis of the euro is a case in point. Like Mark Twain's death, forecasts of the euro's demise have proved premature. Yet at the heart of the simmering crisis lie two debilitating problems with the potential for a devastating interaction. The first is a loss of competitiveness by the peripheral countries, that has left them with depressed levels of GDP and high rates of unemployment. The second is appallingly high government debt. – Telegraph UK

Dominant Social Theme: Things will be okay. Trust us.

Free-Market Analysis: Unlike many mainstream publications, the UK Telegraph often takes an idiosyncratic view of mainstream wisdom, at least when it comes to the European Union. And this article is no exception. It debunks at least some of the latest elite narrative regarding the EU.

It points out that unemployment is on the upswing and that the ECB's current easing measures and low interest rates are probably not going to be enough to combat a continued slump and even significant deflation. This is not the impression that the EU's top men want to give however.

When it comes to the EU, the sub-dominant social themes give way to a larger dominant social theme: The EU is here to stay and those politicians and bankers in charge of the EU will gradually make progress in setting up an increasingly cohesive, peaceful and prosperous society. From many quarreling nation-states will come one merry empire.

Of course, as we have observed many times, this is indeed a meme. That's not how human history works. The greatness of a culture is honed by competition and separateness that allows regions to compete with one another. In this way, taxes are reduced, violence is subdued and the ruling class is made to practice modesty for fear their citizens will simply leave them for a more moderate state next door.

The authoritarianism comes later, of course, once the moderate ruling culture has given way to something despotic, inevitably after the competing city-states have been consolidated.

The European Union is almost a textbook example of this sort of evolution. Each nation-state began as an individual tribal culture and even today there are fault lines, especially in Spain, when it comes to the forcible integration of these tribes into one larger, national agglomeration.

Now the EU proposes to take these unhappy larger regions and consolidate them into a single empire that will mimic Charlemagne's. It is doing so by precipitating a financial crisis that EU top pols intend to translate into political action that will bind the EU closer together.

The trouble is, however, that the current crisis is worse than anticipated and what we call the Internet Reformation has made many people acutely aware of their manipulation and the misery that further EU consolidation will bring.

Increasingly, EU citizens are aware that assurances about the union itself and its prospects are merely lies. The economy is not getting better and constant monetary stimulation is again creating asset bubbles without many positive effects on the real economy.

This brings up additional concerns. Read between the lines and you will discover that it is either improbable or impossible for the ECB to cease stimulation in the near term … or in the far term, either. The positive prognostications regarding the EU and its recovery as well as the solvency of the eurozone remain questionable, indeed.

It is these prognostications that the Telegraph in this article above is attempting to moderate. Here's more:

[The euro] has been extraordinarily strong. When it was launched in 1999, the euro traded at an exchange rate of $1.17. Subsequently, it fell to below parity against the dollar. Yet it has recently been trading at well over 1.30 against the dollar.

The strong euro is directly reducing the cost of imports into the eurozone and it is making it more difficult for the zone to export. The ECB has indicated that it has more ammunition to deploy if things worsen. It may start to impose negative interest rates on banks for making deposits at the ECB.

This, plus the threat of quantitative easing or QE, which the Bank has so far shunned, at least in the pure form, may serve to bring down the exchange rate and thus avert the deflation danger. But I would not bank on it. Divisions in the ECB council will continue to make ECB action hesitant.

Germany is not keen on more stimulative measures and it would surely oppose outright QE. And as we know from the Japanese experience, a hesitant central bank has great difficulty in effecting the all-important psychological changes necessary to stop prices from falling.

For deflation is just like inflation. It is at its most dangerous and is most difficult to dislodge when it gets into the mind. Deflation has been lodged in the mind of the average Japanese person for the best part of 20 years. Germany holds the key to this problem.

What is needed for the eurozone is a combination of a weaker euro and stronger growth of German domestic demand, perhaps facilitated by looser fiscal policy.

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This would mean Germany putting up with a somewhat higher rate of inflation. Yet there seems no sign of Germany embracing either a weak currency or a boost to demand. The result is that the eurozone faces many years of grinding austerity, continuing catastrophe in the labour market and a period of very low inflation, or even deflation.

As debt ratios continue to rise in the peripheral countries, at some stage the financial markets may come to worry again about their ability to stay in the euro. At that point bond yields will rise, thereby making the fiscal position worse. The crisis of the euro is a slow-burning affair. Just like Japan.

Predictions of deflation in this last paragraph are interesting given the amount of money that the ECB has poured into the eurozone. But it likely may come to that in areas of the economy, though not all.

What is also likely is that the securitized portion of the economy will continue to rise. There is an obvious decoupling between the real economy and the financial one. The article singles out Germany as being an obstacle to further monetary inflation but even if German leaders and the electorate were to fully support monetization the results would continue to disappoint just as they do in the US.

Monetary stimulation is a Keynesian concept. While we may have accepted its logic in the past, we have surely been re-educated thanks to modern technology and the information it provides.

What's going on is simple: Money is printed by central banks, provided to large banks that then proceed to aim the money at securitized assets. This enriches the elites who own these assets and further centralizes control of the economy.

What needed to happen years ago – from the point of the elite – was the creation of a dominant social theme to explain this process in terms that made it seem as if the printing of money and the inflation of securitized assets was being done to help the ordinary citizen.

Enter John Maynard Keynes who came up with an elaborate and fantastical theory to justify what was taking place. It was his conceit that sooner or later the money-from-nothing being handed over to banks would somehow find its way into the real economy.

Of course, by the time it did the monetized portion of the economy would be so swollen with asset bubbles that it would soon collapse, re-damaging what was left of the real economy. Keynes's theories grow steadily more ridiculous as we watch the unfolding of this latest "crisis."

This Telegraph article further confirms our perception that money printing will continue and financial instruments will therefore continue to inflate, both in Europe and the US. There will be much hand-wringing about deflation and a lack of jobs, but this is not serious. The system cannot function any other way.

As we have pointed out before, we are in the reflationary leg of a bear-market cycle. There will doubtless be significant volatility but the power elite controlling the financial system seems determined to create yet another blow-off.

After Thoughts

You may not have a job but if you have assets you will be able to participate in it and possibly reap significant rewards if you are careful and pay attention to the timing of additional money flows. Good luck.

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