The European Central Bank Goes Nuclear: Cuts Rates, Announces QE

The ECB’s Keynesian “euthanasia of rentier” has gone nuclear. Aside from the negative deposit rates last June, the latest announcement includes a surprise paring down of interest rates by .1% to .05%, as well as, a QE based on Asset Backed Securities (ABS).

From the Wall Street Journal: (bold mine)

The European Central Bank surprised financial markets with a cut in interest rates and new stimulus plans despite opposition from Germany's powerful central bank, underscoring its urgency in keeping too-low inflation from derailing the eurozone's weak economy….

The ECB lowered its main lending rate by 0.10 percentage point to 0.05%. It cut a separate rate on bank deposits deeper into negative territory, to -0.2% from -0.1%. In June, the ECB became the largest central bank to experiment with a negative rate on bank deposits, a measure aimed at encouraging banks to lend surplus to other financial institutions rather than paying to park them at the ECB.

The central bank also announced it will purchase covered bank bonds and bundled loans known as asset-backed securities and said additional details will be released in October. Mr. Draghi didn't indicate a size for the program, but said the ECB's aim was to get its balance sheet, currently around €2 trillion, back to its size at the beginning of 2012, when it was €2.7 trillion.

A previous covered-bond program in 2011 didn't generate much interest from banks, but reviving it—with the new ABS program—sends a signal of the ECB's resolve to deploy its balance sheet to head off the threat of too-low inflation.

Deflation or “low inflation” amidst weak growth  has been made the bogeyman to justify such measures. The reality is that the Eurozone’s problem has been one of impaired household and institutional balance sheets, therefore the inability to expand credit. In short, the Eurozone needs to clean their finances for them to borrow again. Forcing people to borrow will only add to their existing woes.

Yet the other major obstacles in the real economy such as crushing taxes, various forms of interventions and welfarism have been disregarded. All these represent cumulative symptoms of government interventions. 

The Eurozone has already an amazing record low bond yields. Despite this, the much politically desired (debt financed) spending hasn’t emerged.

What all these interventions has done has been to muddy the investment climate.

Thus the capital investment has been flagging. Companies instead has been returning cash to investors. (chart from FT Alphaville)

And the natural consequence from low investments has been to diminish trading activities as evidenced by dwindling intra-EU trade.(chart from Zero Hedge). 

Reduced trade activities simply extrapolates to low economic growth.

Of course not everything has been bad. Zero bound and negative rates has signified a subsidy to government activities.

Political spending in the region has mostly increased (chart from Dan Mitchell).

And given the low growth environment, these has ballooned government debt-to gdp (Zero Hedge).

Government debt according to the Eurostat as of July has been at 93.9% of GDP

So subsidies via financial repression has not only kept government debt levels afloat, they have encouraged even more unproductive debt accumulation. Yet whatever government resources consumes means resources taken away from the private sector, hence the low investments and low economic growth environment

And there’s more. Because Keynesian dogma of the “euthanasia of rentier” have been designed to promote debt, companies have taken in on risk debt from capital markets to record levels. Here’s the Wall Street Journal: The prospect of quantitative easing in Europe is reviving the market for risky bank debt, with two European lenders testing the waters on so-called contingent capital, or CoCo, bonds after a monthslong drought. CoCos—which can convert to equity or be wiped out if the issuer's capital levels drop below a threshold—had a booming start to the year as banks took advantage of record low rates to bolster their balance sheets ahead of a banking-system health check this fall. Issuance surged to a record €33.6 billion ($44 billion) in the first half of the year, before the market ground to a halt in July when financial difficulties at Portugal's Banco Espírito Santo and U.S. Federal Reserve Chairwoman Janet Yellen's warning about the high price of risky debt prompted investors to pull back

And aside from the US Federal Reserve providing bridge finance to Eurozone companies via Overnight Interest Rate on Reserves, much of these borrowed money may have most likely been powering financial asset speculation. The Stoxx 600, a composite benchmark of 600 companies, has been levitating at multi-year highs. 

So the Eurozone has been experiencing a fantastic parallel universe; listless economic activities in the face of a financial asset markets boom

And with the Euro being clobbered, the likelihood is for the currency to be used as funding currency in potential carry trades which may further provide fuel to the amplification of global asset speculation orgy. And this is why many drool over the ECB's recent actions.

Meanwhile, a weak euro may spawn a reversal in the bond rallies in Eurozone's periphery economies as money flows elsewhere in search of higher returns.

At  the end of the day, the ECB’s euthanasia of rentier only adds to the imbalances to the Eurozone’s fragile economy which may spillover to the global economy via a global bubble cycle.

As the great Austrian economist Ludwig von Mises presciently warned: (bold mine)

Public opinion is prone to see in interest nothing but a merely institutional obstacle to the expansion of production. It does not realize that the discount of future goods as against present goods is a necessary and eternal category of human action and cannot be abolished by bank manipulation. In the eyes of cranks and demagogues, interest is a product of the sinister machinations of rugged exploiters. The age-old disapprobation of interest has been fully revived by modern interventionism. It clings to the dogma that it is one of the foremost duties of good government to lower the rate of interest as far as possible or to abolish it altogether. All present-day governments are fanatically committed to an easy money policy…Many governments, universities, and institutes of economic research lavishly subsidize publications whose main purpose is to praise the blessings of unbridled credit expansion and to slander all opponents as ill intentioned advocates of the selfish interests of usurers.

The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

All these reckless experimentation for the sake of protecting the interests of politicians, bureaucrats and their cronies.

Yet the massive misallocation of resources from manipulation of interest rates paves way for a depression (soon).