10/7/19: Financialising Stagnant Growth: From Japanified Economy to Christine Lagarde

Monetary policy since the GFC of 2008 has been characterised by the near-zero (and even negative) policy rates, negative bank rates, negative Government debt yields and rampant asset price inflation. The result has been zombification of the advanced economies.

Here is the latest advanced estimate of the Eurozone real GDP growth based on the CEPR/Banca d'Italia Eurocoin indicator:

Current forecast for 2Q 2019 growth in the Eurozone, based on Eurocoin indicator is for 0.17% q/q expansion. June Eurocoin sits at 0.14%, the lowest since September 2013. The growth rate forecast has now been sub-0.25% (below 1% annual) in five months (through June 2019) and counting. Meanwhile, the link between growth and inflation has been weakening, as shown in the chart below:

Both, from the point of view of view of the current data relative to 1Q 2019 and to 2Q 2018 and to Q1 2018, growth rates are shrinking, per above. The ECB, however, remains stuck in the proverbial hard corner (chart next):

 Five years into zero policy rates, inflation is gradually creeping up (chart above), but growth is nowhere to be seen (chart next):

Worse, tangible fundamentals (captured by the models, like Eurocoin) of economic growth are becoming less and less consistent with actual growth outruns - a feature of the economy that is becoming dependent on things other than real investment and real demand for generating expansion in GDP. Both, the chart above and the chart below, highlight this troubling fact.

All of this suggests that we are in the period in economic development that is fully consistent with the secular stagnation thesis: traditional tools of monetary and fiscal policies are no longer sufficient in generating real economic growth. Instead, these tools help sustain economies overloaded with debt. It is an extend-and-pretend model of economic development: as long as corporates and households can be supported in carrying existent debt loads through monetary accommodation, the economy remains afloat (no recession, nor crisis blowout), but the levels of debt are so prohibitively high that no new debt can be accumulated to generate economic expansion.

The markets know as much. Investors know that zombie loans (loans with no capacity of servicing them should interest rates rise) mean zombie banks. Zombie banks mean zombie new borrowing markets. Zombie new borrowing markets mean zombie real investment by households and companies. Zombie investment means zombie demand. Zombie demand means deflationary supply. Rinse and repeat.

This knowledge in the markets is tangible. It takes a change in investors expectations (as in recent changes in outlook toward the reversal of the monetary tightening in the U.S. and Europe) to reprice assets. No actual value added growth enters the equation. Assets are no longer being priced on their productive capacity. And the markets are now fully finacialised. Which is to say, they are now fully monetary policy-driven.

Enter Christine Lagarde, the new head of the ECB. Lagarde's appointment is hardly an accident or a politically correct nod to women in leadership. It is the only logical choice of the financialised zombie economics of the monetary policy. To re-start borrowing or debt cycle, the EU is hoping for mutualisation of the sovereign debt markets. In other words, it is hoping to leverage the only unencumbered asset the EU still has: surplus countries' bonds. Lagarde's job at the ECB will be to run the creation of the eurobonds, bonds that will proportionally link euro area members' bonds into a single product to be monetised by the ECB as a support for market pricing. There is probably EUR 2-3 trillion worth of the international and monetary demand for these, opening up the room for more borrowing and more fiscal spending.