Thursday, May 21, 2015

Mario Draghi’s ECB Inflates 5 Eurozone Bubbles

When central banks drench the system with money—with the supposed aim to stimulate the economy and or to ignite headline inflation—the money stream flows to only some of the sectors. 

(Of course, that's the headline justification which shields the real reason: subsidy to debt strained government and politically privileged industries)

And those sectors that experience the initial “pump” will then draw in a bandwagon (performance chasing) effect from the marketplace. 

The misallocation of resources from political intervention of money represents THE bubble. Bubbles signify as “something for nothing” phenomenon or from the religious belief of expectations elixirs (free lunches) from money creation.

So when ECB Draghi declared that the region’s central bank would “do whatever it takes” to save the EU, the ramifications of her policies, like everywhere else has been to blow bubbles.


Marketwatch’s Matthew Lynn identifies 5 bubble areas where ECB balance sheet inflation has diffused to: (bold mine)
Here are five markets that are already benefitting from the tidal wave of money Draghi has created.

First, take a look at Spanish construction. Only a couple of years ago, we were reading about how Spain was littered with empty housing estates and airports with one flight a day, the forlorn legacy of the building boom that was raging all through the middle of the last decade. You might think there was nothing left to build — but, as it turns out, you’d be wrong. The cranes are back in action again. Construction output in Spain is currently growing at 12% year-on-year, by far the fastest sector of the economy. Cement consumption is up by 8% this year. The property market is humming again.

Second, Dublin housing. There were few hotter markets at the height of the last boom than Irish housing — nor many crashes that were quite so bad. Now, the froth is back again, and anyone who snapped up a bargain as the country was bailed out and its banks went into intensive care will be feeling smug by now. Irish houses prices are up by 16% year-on-year, and by 22% in the capital, Dublin. The emerald tiger is catching another wave of hot money, and starting to boom again. Don’t be surprised if prices keep going even higher.

Third, German wages. For a decade, despite having supposedly the strongest economy in Europe, German wages had hardly risen. Now that is starting to change.The metalworkers union just secured a 3.4% rise, a decent hike in a country where deflation is still a threat, and prices are not likely to rise. Other workers want a better deal as well. This week, the train drivers are on strike, for the ninth time in the last year, as they push for a 5% pay rise and a shorter working week (who says the trains in Germany run on time). Already in 2015 Germany has lost twice as many days to industrial action as it did during the whole of 2014, according to the German Economic Institute. By the end of the year, wages in Germany are likely to be racing ahead at record levels.

Fourth, Maltese assets: The tiny Mediterranean island is expected to record the fastest growth in the European Union this year, at 3.6%. Prices are not rising quite as fast as they are in Dublin, but property is up by 10% year-on-year, the second fastest rate in the eurozone. Some of the local banks are reporting that their balance sheets are expanding by 40% a year or more. Has the Maltese economy suddenly had a surge of competitiveness? It seems unlikely. In fact, it is emerging as the new Cyprus — an offshore haven for all the hot money within the eurozone to find a temporary home.


Five, Portuguese stocks: It is hard to think of anything very good to say about the Portuguese economy four years after the country had to be bailed out. The economy is only expected to expand by 1.6% this year, only marginally better than the 0.9% it managed last year. Unemployment is still running at more than 13% and shows little sign of falling significantly. But, hey, you never guess that from the stock market. Lisbon’s PSI Index  is up by 25% this year already, making it one of the strongest markets in the world.

In reality, central banks can print money when they want to . But they can’t control where it washes up. Some of the rising markets might be useful — higher wages in Germany, for example, might help to rebalance that country’s massive trade surplus.

But in the main Draghi’s tidal wave of euros is most likely to simply to blow up another series of asset bubbles. Indeed, in many cases they are exactly the same bubbles that blew up last time around, such as Spanish construction and Dublin property. That may be great for investors who get in on those markets on the way up. But it won’t do much to fix the eurozone economy — and it will inevitably be very painful when they finally pop.
The ECB tsunami money has designed to ease interest rates or debt servicing costs. 

So the crucial question will always be: how will bubbles be funded?

The answer gives us a clue to the mother of all of Europe’s bubbles: DEBT!

The previous bubble implosion resulted to an explosion of Europe government’s debt levels as a result of collapsed tax revenues, as government spending ballooned accentuated by bailouts.


That’s European government’s skyrocketing debt as of 2013 according to ECB data. Hockeystick debt!

This is expected change in government debt as % of GDP based on McKinsey Global estimates

Expect mainstream expectations to be conservative once the bubble pops.



In spite of the reemergence of bubbles (which has and may temporarily spruce up statistical G-R-O-W-T-H) government debt for European nations particularly the crisis affected ones, namely, Portugal, Spain and Italy, has increased! (with the exception of Iceland and Ireland). Yet the decrease in Ireland’s debt has been marginal.


The above red box represents Europe’s staggering combined private and public sector debt in % of GDP as per McKinsey approximations. 

Those new bubbles are likely to inflate more systemic leverage (most likely centered at non financial corporates).


Finally early this year, a big symptom of the debt bubble has been negative yields.

Negative yields have mainly been a product of a massive stampede to frontrun the ECB (asset buying) by the banking financial industry (the other major beneficiary of the ECB stimulus). 

Negative yields then meant that borrowers were even being paid (rewarded) to borrow!


But recently treasury markets like yields of 5 year German bunds have seen a forceful pushback.

Whether this has been temporary or has accounted for growing cracks in the bond bubble remains to be seen.

Yet the next bubble implosion will not just apply to asset bubbles but to the entire debt portfolio of the region (and elsewhere). 

The most likely outcome will be a horrific deflation (chain of debt defaults), or if the ECB fights it with money printing, possibly hyperinflation.

Bankrupt governments depend on sustained access on the credit markets for them to survive. This makes them highly sensitive to market confidence. And such has been the real thrust of all the cumulative easing policies implemented by the ECB (and by governments). 

Once market confidence dissipates, the whole bubble edifice crumbles.
 
Greece may likely be the first casualty.

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