Tags: Eurozone | ECB | Yellen | QE

Eurozone Needs to Get on Sustainable Growth Track

Tuesday, 26 August 2014 09:21 AM Current | Bio | Archive

Last week, the Kansas City Federal Reserve's yearly economic policy symposium was held in Jackson Hole, Wyo. As expected, the two most important speeches were delivered by Fed Chair Janet Yellen and European Central Bank (ECB)'s President Mario Draghi.

Yellen really didn't surprise anyone with her speech, although she gave the impression of taking on a slightly more neutral stance on the Fed's policy in the months ahead, while admitting that if the U.S. economy maintains its recent growth path, the Fed's long-awaited start of its long way back to "normalization" of its monetary policy could start earlier than generally is expected.

She stated clearly: "If progress in the labor market continues to be more rapid than anticipated by the Committee [the Federal Open Market Committee (FOMC)] or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter."

In the context of what Yellen said, I think it would be interesting to give some attention to what St. Louis Fed President James Bullard, who is undoubtedly more hawkish than the majority of the actual voting members of the FOMC, told the Financial Times: "The committee has two things [in the policy statement] that I think are going to need to be modified. One would be the word 'significant' for labor market underutilization, and I think we can't stick with that phrase for too long, as unemployment continues to decline and jobs growth continues to be quite robust."

Secondly, he noted, he would now prefer language that links rate increases more clearly to the state of the economy, rather than the "considerable time" language used in the FOMC statement. He stated: "I do think we need to work on that, and get something more state-contingent, but still convey the sense of the Committee about what we think is going to be a good policy going forward."

Interestingly, he expects the so-called "lift-of" to "normalization" to occur in the first quarter of 2015.

Personally, I think what he said later in the article is important to all investors who are still way too complacent and therefore act like markets only can go up: "To have markets trading more dovishly than what the Committee is intending, I think suggests there'll be a day of reckoning at some point in the future — either for us or for them."

It might be good for long-term investors to keep in mind that bottoms in the investment world never end with four-year lows, but most of the time end with 10 to 15 year lows. I don't think this time will be different when the big wave starts its downward move.

Draghi in his speech was somewhat more surprising than Yellen was, at least in my opinion, when he admitted the ECB monetary policy was facing a failure that had been caused in a large part because of its stringent monetary policy. This becomes more significant when one takes into account what he said in London in July of 2012 at the Global Investment Conference: "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough."

Of course, in July 2012 Draghi couldn't foresee how the eurozone would perform in August 2014 and that it would be facing stagnating growth, at best, with even Germany now also closing in on zero growth, and France and Italy, the eurozone's second and third most important economies, back into recession. Moreover, the eurozone still faces an unemployment rate of 11.5 percent. In Greece, youth unemployment stands at 56.3 percent, in Spain it stands at 53.3 percent and in Italy it stands at 43.7 percent. Those eurozone countries face literally lost generations.

Draghi also alluded in his speech to quantitative easing (QE), without mentioning it specifically. Everybody knows that if the ECB would ease further its monetary conditions, for example, with some form of QE, it would stimulate the economies of the eurozone as well as weaken the euro, which is way too highly priced for all these still weakening economies.

Now, the ECB buying on a full-scale basis eurozone government debt already faces opposition from the German Central Bank, as Bundesbank President Jens Weidmann says such an undertaking would be: First, outside the mandate of the ECB, and secondly, practically pointless because euro area government debt yields are already at historically low levels. For instance, 10-year government bond yields are 0.94 percent in Germany, 1.30 percent in France (which is in recession), 2.25 percent in Spain and 2.47 percent in Italy (also in recession).

Now, there is no doubt the Bundesbank is right in what it says about the ECB's mandate, but also on a practical basis, if the ECB doesn't find a significant and durable solution to weaken the euro, as would be the case with QE, there is the real risk the eurozone's economies could get trapped, once again, in a downward spiral that brings them back to the crisis situations of 2010 and 2012.

In my opinion, it would be a complete disaster if the eurozone would have to face these kinds of crises once again. There is no doubt in my mind the specter of one or even more exits of the eurozone would reappear rapidly, which would bring the whole eurozone back into a chaotic situation that would be extremely threatening to the continuation of the eurozone in the form as we know it today.

Let's hope it doesn't come to that because that could have very grave consequences for all the major economies in the world.

Of course, the ECB could weaken the euro significantly with large-scale unsterilized unilateral interventions in the foreign exchange markets by making direct bond purchases of non-eurozone governments, such as buying U.S. Treasurys, as well as other government bonds like U.K. Gilts, which would probably not run into opposition of the Bundesbank. Now, take care, for such an operation to be successful it should be done on a sufficient scale, which means really big and in an astute way.

On the questions: Is it doable? My answer is yes! Will it be done? I must say, I don't know.

So, there still remains a significant part of uncertainty coming from the actual situation in the eurozone.

Long-term investors should take notice because if the eurozone can't get back on a sustainable growth track in a relatively short time period, all investors will face a series of negative impacts of various degrees depending on wherein they are invested.

Finally, don't be surprised if in the coming days the euro moves somewhat higher because it's, technically speaking, really in an oversold position. Once done, its downward trend should re-initiate after a short while.

Also, don't be surprised if you see during the first days of September somewhat better GDP numbers coming out of the eurozone, as the European Union will adopt from now on the new global standards for what counts as output, which now will include research and development, but also illegal activities and a whole range of activities.

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Last week, the Kansas City Federal Reserve's yearly economic policy symposium was held in Jackson Hole, Wyo. As expected, the two most important speeches were delivered by Fed Chair Janet Yellen and European Central Bank (ECB)'s President Mario Draghi.
Eurozone, ECB, Yellen, QE
Tuesday, 26 August 2014 09:21 AM
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