30 December 2011

Euro Area in 2012 and Onwards: Two Contradicting Trends to Watch

During the Christmas Holiday I finally managed to read through the Economist’s paper publication “The World in 2012” (I read the Economist’s predictions for the coming year since 2007). As usually, there were lots of politics, lots of guessing and opinions, some articles that looked like hidden campaigns or self-justification, and a few interesting pieces about business, science etc.

The one thing that stood out in this year’s leaders was the strong criticism towards Europe’s current strategy of austerity measures. On the other hand, it became apparent from the other articles that the real economy is learning to operate more efficiently and more effectively. Thus, we have two contradicting trends to watch in 2012:
1) the (anonymous but loud) markets crying for the ECB to start printing money, and
2) the real economy striving towards low-cost solutions, and actually needing less cash for doing the same things.

Trend no. 1: Easing monetary policy in Eurozone

One might get an impression that even media knows what should be done; only the “stupid” German’s policy makers (and the policy makers of some other countries that have their finances in order) and the ECB are messing everything up. The headings such as “The year of self-induced stagnation” and expressions like “the obvious failure of Europe’s “muddling through” strategy” and “an excessive embrace of short-term budgetary austerity” should be self-explaining.

The ECB is under strong pressure of really starting printing money, and in certain form, it has begun already (despite of remaining moderate in its communications). As an example of the pressures, read what some of the largest European banks (both, inside and outside of the euro area) are seeing as a new hope and/or wishing or (explicitly or implicitly) suggesting as a “Christmas present”:

* “Although this would not be a sufficient long-term solution, an ECB commitment to a more massive asset buying programme (whether directly in the form of quantitative easing, or indirectly by financing another organisation) could mark a turning point some time in the year. We believe this scenario is quite possible, although we do not expect it in the first quarter of 2012.” (BNP Paribas, “Investment Strategy 12 December 2011”)

* “The ECB has already started giving out early Christmas presents in the form of long-term loans with lower security in order to strengthen the weak and capital hungry banking sector in Europe, extending credit to companies and households and indirectly also consolidating budgets in the crisis countries.” (Cecilia Hermansson, the economist of Swedbank on 22 December 2011)

* “From a practical point of view, we think that an emergency European Council should be organised as soon as possible to deliver the letter of intent which could allow the ECB to step up its interventions and act as lender of last resort.” (Deutsche Bank, “The Markets in 2012. Foresight with Insight”)

* “However, for this moderately better outlook to materialize, it is critical that investors’ concerns start to ease. In spite of unprecedented fiscal and structural adjustments throughout the eurozone periphery, investors remain on the side-line. They are concerned about the ECB’s hesitant stance towards restoring a proper transmission mechanism, which has led to unsustainable differences in monetary conditions across the eurozone.” (Unicredit, 2012 Outlook)

A look to the investors’ communities confirms that in one or another form, quantitative easing is what many investors actually expect from the ECB in 2012. The reason is simple: the current financial/economic equation just does not play out without additional money in the system (first of all, remember the basic principles of money and interests, and then all the creative structures that have been derived from the credit), and the outside world is not eager to lend to the troubling eurozone governments.

Trend no. 2: Less money needed for getting things done

The above argumentation about the need of the ECB to print money does not make sense to common sense. Common sense suggests that if a household, company or government earns more than it spends, it will be able to repay its debts. What is needed is to be more effective.

Increased effectiveness is what the Germany’s approach and strict credit terms are suggesting to the consumers, companies and governments. Indeed, money supply and credit have remained almost unchanged in Europe in 2011, at least before Mario Draghi took over from the Jean-Claude Trichet as President of the European Central Bank on 1 November 2011 (see Figures 1-a and 1-b). No wonder that Europe has been struggling; structural changes rather than quick fixes inevitably take time.

But new technologies and innovative business models (e.g. sharing rather than owning) actually make the increased effectiveness possible, even up to the point where the whole banking system as we know it today becomes obsolete (ok, not in 2012 and maybe not during the coming 10 or 20 years, but at some point in the future for sure). That’s from where the second trend derives: great stuff will be made available for lower cost, and to more customers.

Yet apparently, even more of those that are less effective, would become obsolete; without the possibility to roll over their existing loans, many more would default. The European banking system would not survive this without help. Thus, the ECB is facing a choice which really is not a choice but just a matter of time.

At first, more money will make the banking system look stronger thanks to the improved liquidity and capital ratios (of course, with the expense of lower profitability). The real economy will see only a little more credit from banks, and most probably for a higher price. Next, the “money game” is likely to become even more like a game: higher stakes, higher risks, more “players” in the risky game. Different forms of capital could be expected to become available more easily, but then money is probably worth much less than it’s today.

For one thing, I do share the Economist’s prediction that the World will not end in 2012. Happy 2012!

1 comment:

  1. A great article, thanks! - Ruslan