90 seconds at 9 am: Europe on edge

Pressure off oil prices; ECB to act against deflation; EU-US trade deal progresses; Holden recalls cars; NZ$1 = US$0.855, TWI = 79.8

27th May 14, 7:51am by David Chaston

Here's my summary of the key news overnight in 90 seconds at 9 am, including news mainly about Europe.

The oil price fell, both US benchmark and the Brent, as it seems tensions in the Ukraine were the main thing that pushed it up in the past few weeks and markets think those are ameliorating following the weekend election of the chocolate tycoon.

In Europe, ECB boss Mario Draghi said they are ready to act next week to ward off deflation. The worry is that consumers will delay purchasing if they think goods will be cheaper in the future and this creates a negative loop.

He said overnight the key issue was the timing of any action. They are working on a package of measures for their meeting on June 6 (NZ time), including interest-rate cuts and liquidity injections, while holding out the prospect of quantitative easing as a more powerful future option.

The risks are high. Japan is facing something now that Europe may face in the future: successfully averting deflation but without seeing growth as a result.

Policy makers need to be careful in Europe after sweeping election gains by parties of the far right and far left, all euro-sceptics.

Negotiators of the potentially huge US-Europe trade agreement, the TTIP, have signaled they are actually making good progress across a broad front of issues, surprising many.

Closer to home, Holden is recalling more than 42,000 cars in Australia and almost 4,000 in New Zealand over a potential seat belt fault. It seems they are all 2014 models.

New York markets are closed today for their Memorial Day public holiday.

On the exchange rate, we start today with the NZ dollar virtually unchanged at 85.5 USc, at 92.6 AUc and the TWI is now at 79.8.

If you want to catch up with all the changes on Friday, we have an update here.

The easiest place to stay up with today's event risk is by following our Economic Calendar here »

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21 Comments

by Roelof | 27th May 14, 8:18am 1401135502

....including interest-rate cuts and liquidity injections, while holding out the prospect of quantitative easing as a more powerful future option.

Liquidity injections = money printing = QE.. Money printing Money printing Money printing.. ( fancy phrases to describe an old game )

In the face of what should be global deleveraging.... this is their only weapon/tool.... money printing...... but it is not really a tool/weapon... as there is no such thing as .."a free lunch"..

Someone bears the cost of "new money..

by MortgageBelt | 27th May 14, 8:21am 1401135708

Most other developed economies are fighting Deflation.

While NZ lives in a 2002 time warp spreadsheet & is still warding off imaginary inflation foes.

by Boatman | 27th May 14, 8:51am 1401137519

How on earth does one stop deflation , its far more damaging than inflation , and harder to eradicate .

Events in Eurpoe show the market is not stupid. Individuals collectively ( the market) acting in self interest it will delay spending if they beleive the price of something will fall .

Even I have delayed getting any new stuff if I think that the strong Kiwi$ and the lower Yen , Yuan and Aussi$ will result in stuff coming down even more in price

Thants what markets do , and you cannot get rid of the problem easily

by steven | 27th May 14, 9:17am 1401139043

You stop deflation or maybe we'll say dis-inflation as that's how it starts by carrying on overall spending. So if the private sector reduces spending the pressure of inflation drops away as we have seen for 6 years now. If the Govn also stops spending the overall pressure is significabtly depressionary. Present day examples of that abound over the last 6 years.

We are not in overall deflation yet so while "acting in self interest it will delay spending if they beleive the price of something will fall ." is a classical view, before that we see over-capacity which we have, in spades.

Where oe why we dont see deflation is in some areas is because energy is now 4x the price it used to be, hence we see push inflation.

To combat this we drop interest rates, (classic keynesian) or that is what Greenspan did. Trouble is dropping rates should be a signal that there are structural imbalances that have to be fixed. Greenspan and Bushie et al didnt fix these so wasted the time an interest rate drop gave and just kept repeating that drop til we hit the lower bound.

Goods take energy and materials to produce, if the cost of the inputs exceed the return for the finished product the free market will cease production of that item. So waiting for a cheaper deal may actually see you miss out.

Personally I dont buy a lot of new stuff as such, but if I do I look at the return its going to give me. If using debt (interest free deals) rather than cash to buy it makes sense because the return or utility advantage in that time span is greater I do it.

regards

by Anarkist | 27th May 14, 11:32am 1401147177

"How on earth does one stop deflation , its far more damaging than inflation , and harder to eradicate .

Events in Eurpoe show the market is not stupid. Individuals collectively ( the market) acting in self interest it will delay spending if they beleive the price of something will fall ."

The anti-deflationary hysteria is peddled by vest interests who's income is derived from speculative capital gains which are virtually guaranteed in an economic climate defined by steady inflation and high government deficit spending. People like Bill Gross of PIMCO are being disingenuous when they take a stand against government debt levels, because high government spending mops up excess capital which would otherwise dampen bond returns. They use it as a ploy to rationalise their opposition to government providing assistance to anyone but themselves.

http://www.zerohedge.com/news/2013-05-10/bill-gross-tweets-bond-bull-ma…

Its not even premised on a logical theory. The economy is a dynamic system and people have different priorities, spending habits, and strategies. Orthodox economics is based on constants and a closed economy. Deflation rarely is constant, routinely self-corrects, and intervention by the government or monetary authories almost inevitably lead to an abrupt swing in the other direction. In fact falling prices would lead the vast majority to purchase now rather than later, because who has total confidance in their predictive ability? How many people take into account relative exchange rates, market trends, and developments in the wider economy when making decisions? Most people only take into account the price relative to their current spending power with a marginal few their future income prospects even when bough on credit.

The problem isn't people's future expectations about falling prices, thats just an idiot postition to take. Its because a significant section of the populace in Europe lack an adequate income to purchase what they would otherwise buy.. Otherwise known as effective demand. Oh no can't say that. That smacks of socialism. To think due to market and political failures people can't buy whats on offer in the market place, because they lack an income in contravention of Say's Law and the Efficient Market Hypothesis.

by Drawdown | 27th May 14, 9:49am 1401140988

Is it time to admit that money printing (QE) has worked. It stopped a great recession becoming a great depression, stabilised asset prices, forced the USD lower, stimulated their export sector and helped them get back to growth. Classical economic theory would suggest that a country borrow and spend their way out of recession but this always comes with a big debt hang over. When you consider that excessive debt created the recession in the first place it would seem crazy to create more debt as a way out. The main argument against printing seems to be that when you stop/taper you get deflation but another way of looking at this is a very direct control or lever on inflation. I believe it has set a precedent for QE to be used as a mainstream macro prudential tool.

by DFTBA | 27th May 14, 10:14am 1401142470

The extra cash did not really make it into the 'wroking' economy. It's been sloshing around various stockmarkets and has created a few bubbles along the way.

It will be interesting to see what will happen when the spill gets mopped up.

by Drawdown | 27th May 14, 10:18am 1401142723

I admit that the current method of distributing QA is flawed (via the banks and largely into stocks) it would be simple to redistribute the printed money directly into the productive sector. Infrastructure spending, cheap business loans, government debt reduction, all these kinds of productive spending could be used to offset any deflation resulting from reduced QE distribution via the banks.

by DFTBA | 27th May 14, 10:24am 1401143088

Yup.

by Andrewj | 27th May 14, 10:07am 1401142045

"I didn’t expect there are countless reporters hiding [in the audience],” he said. China’s once buoyant property market is facing some rough sailing. In fact, according to one tycoon – Soho China chief Pan Shiyi — the real estate market is looking more like the Titanic headed in the direction of an iceberg. Mr. Pan, the co-founder and chairman of Soho China Ltd., is taking a very bearish view on the housing market, which has struggled this year. In the first four months of the year, home sales were down 9.9% from the same period a year ago in value terms, official data shows. New construction starts — as calculated by area — were down almost 25% year over year in the same period. As if that’s not bad enough, demand is also weakening in an expanding number of cities as banks tighten mortgage lending and sales are dampened by widespread expectations of price cuts. “I think China’s property market is like the Titanic and it will soon hit an iceberg in front of it,” Mr. Pan told a financial forum on Friday, according to the China Business News. http://blogs.wsj.com/chinarealtime/2014/05/26/tycoon-sees-titanic-momen…

by Stephen L | 27th May 14, 10:17am 1401142654

Drawdown,

Clearly QE has worked, for all countries practising it: the US, China, Japan, the UK, the Swiss, while the Germans had gamed the Euro for the 15 years prior to the GFC. Those countries not playing the game have suffered competitive disadvantages and loss of capital as a result. I have a view nevertheless that QE could have been more efficiently and effectively applied if channelled through tax cuts at low income bands- as I believe Helicopter Ben advoctaed in the text book he wrote on the depression. Tax cuts would have raised real wages, kept consumption higher, and gradually made debt more manageable.

Channelling the money through the banks has clearly blown asset bubbles in the hope that wealthier feeling people would spend more. I suspect Ben chose the bank route for political reasons- the bank and wealth lobby is very strong. The process has worked as you say, but could have been better applied in my view.

The main opportunity for NZ may have passed, with fair loss of national wealth in the meantime, but there is still time to limit future currency caused current account damage.

by Drawdown | 27th May 14, 10:34am 1401143643

See my reply above regarding the QE distribution method. The banks did need support at that time, the moral hazard in ‘bailing’ them out in this way is clear. The major economic threat of our time is, in my opinion, the accumulation of debt and its burden on the productive sector and inflation of the non-productive investment sector. Without trying to sound over-dramatic; QE does seem to be the silver bullet to this threat. Any deflationary risks resulting from reduction in debt can be offset by money printing and spend in the productive sector. Over time we have a reduced debt burden and a more direct ‘lever’ on inflation/deflation.

by Anarkist | 27th May 14, 12:55pm 1401152131

The major economic threat of our time is, in my opinion, the accumulation of debt and its burden on the productive sector and inflation of the non-productive investment sector. Without trying to sound over-dramatic; QE does seem to be the silver bullet to this threat"

The accumulation of debt is merely the symptom of the wider problems in the economy. Debt is just obverse side of production. Its in essense time to pay due to the fact that consumers lack the means to immediately purchase the fruits of the industrial system. The greater problem is the distribution of income and stored wealth. It matters not in terms of ethics whether one's wealth is justly earnt, inequality has real economic consequences.

Monetary and fiscal stimulus just paints over the problem and defers the necessary political and economic adjustments. What those adjustments need to be or who should carry them out isn't for me to say, but they need to take place eventually.

You can't simultaneously have more deficit spending and and reduced debt burden with low inflation. Its just not possible. National debts never get paid, just rolled over and only the debt to GDP changes with the fortunes of the economy. With a stabilising population, falling marginal costs, and dwindling resources we can't guarantee economic growth will be able to pay off the debts assumed by our governments.

by Drawdown | 27th May 14, 1:42pm 1401154938

“You can't simultaneously have more deficit spending and reduced debt burden with low inflation. Its just not possible.” I beg to differ, our heavily indebted society is very reliant on debt growth for our economic growth, if you constrain the debt supply through steadily increasing capital adequacy requirements this will cause deflation that can and should be offset by money printing and spend in the productive sector; with the aim of little to no inflation or deflation. There will come a point where the debt burden is so low that its supply has little effect on inflation or deflation, it is at this point that we could comfortably say that the debt burden has been relieved. From this point I would advocate using QE to avoid deflation and other macro prudential tools (for example tax and population limits) to avoid inflation. Existing debt, govn and indivduals, can be gradually paid down to more acceptable levels.

I will concede that inequality is more difficult to address… a broad debate that would include unions, the free market, tax, globalisation and more.

by Anarkist | 27th May 14, 2:55pm 1401159342

One solution would be to harmonize capital adequancy rations, because the current rules derived from the Basel Accords skews bank funding towards real estate.

"he Accord can be summarised in a couple of pages. In essence, it states that for every $100 of loans, a bank should have at least $8 of capital, of which at least $4 must be permanent equity. Because loans secured over residential property were seen to be less risky than other loans, they only had to have 50% as much capital."

http://www.rbnz.govt.nz/research_and_publications/speeches/2001/0104984…

Your recommendations have a high chance of failure. China attempted to plan its monetary policy on that basis, but they only succeeded in blowing a property bubble of an unparalled scale.

"Today, the Chinese government, for the sixth time in just 10 months decided to raise reserve requirements by 0.5%:points, to 10.5%. If they keep this up, fractional reserve banking will be ended in China by 2033! "

http://stefanmikarlsson.blogspot.co.nz/2007/04/china-worlds-largest-for…

If government officials in China with almost absolute power can't manage their economy with those tools at their dispoal what do you imagine the chances of the New Zealand government with far more constrained powers would be?

There are hints of Social Credit in your recommendations, though I don't think Major Douglas had quite the same faith in the capabilities of the technocrats as you apparently do.

To start an investigation of modern day economic problems one could do well to read a description of Major Douglas' economic thought here.

"If the quantity theory of money is a fallacy, then why does there appear to be a direct relationship between money supply and price levels in the long run? This is due to a third factor which influences both. This factor is the increase in overhead charges relative to income as efficiencies in production are realized. Douglas stated in his first article, “The Delusion of Super – Production”, "it may almost be stated as a law that intensified production means a progressively higher ratio of overhead charges to direct labour costs”. According to Douglas’s A+B theorem, prices equal A (income) plus B (overhead charges). If overhead charges are constantly increasing relative to income, then in order to maintain or increase income, prices must rise. "

http://social-credit.blogspot.co.nz/2011/01/quantity-theory-of-money.ht…

This tendency has only become more apparent since Western corporate began to transfer their production to poor emerging economies in South East Asia and Eastern Europe. The fact that Head Quarters costs and managerial overhead that are now continually escalating as the complexities of managed dispersed supply chains continues to grow only exacerbates the problem in terms of individual economies.

"Just how massive is the 100% non-value adding waste at corporate headquarters in these companies? At P&G – a train wreck of a company if there ever was one in terms of having no clue as to what adds value in the eyes of customers and what doesn’t – 25¢ out of every dollar they charge for soap goes to pay the utter waste of headquarters. A third of the price of a can of Coke or Pepsi goes down the headquarters rat hole. L’Oréal – the big cosmetics company flushes 20% of the moany you pay them down the corporate drain – which makes them twice as lean as competitor Estée Lauder, which squanders nearly 40¢ on the dollar on expenses customers are wholly unwilling to cover."

http://www.idatix.com/manufacturing-leadership/the-high-cost-of-cheap-l…

These types of companies are only able to stay afloat because they're increasingly employing the ploy of booking surplus inventory in their accounts as sales.

In the second we learn that the auto companies – GM especially and Toyota not at all – are padding their sales numbers by adding inventory: “Some 3.27 million new cars are now sitting on lots across the U.S., more than there have been in almost five years, according to Automotive News.” “General Motors, for example, has enough Cadillacs finished to meet demand for more than four months. It also has 85 days’ worth of Buicks ready to roll. (At the other end of the spectrum, Toyota and Subaru are running lean—current U.S. inventories for both companies should be gone in less than 60 days.)”

http://www.idatix.com/manufacturing-leadership/and-they-think-inventory…

by Drawdown | 28th May 14, 1:28pm 1401240519

“Your recommendations have a high chance of failure. China attempted to plan its monetary policy on that basis, but they only succeeded in blowing a property bubble of an unparalled scale.” I would hesitate to use China as an example due to the vagaries of the data that they produce and the enigma that they are. China has unprecedented economic growth and even without leverage this growth could increase property prices; I could only suppose that without the additional capital requirements property values would have increased more than they have. I believe a better real world example is right here in NZ, the RBNZ’s LVR’s. Whilst these are capital adequacy requirements on the individuals only, the property data since their inception reflects a positive effect on the market. Whilst I don’t necessarily advocate an end to fractional reserve banking I think capital levels should be significantly increased; to what level could be determined on the fly.

“To start an investigation of modern day economic problems one could do well to read a description of Major Douglas' economic thought here….” – interesting, thanks, I currently work for a large corporate and have worked for many over the years. Your figure of 1/3 of the price of soft drink going to pay for corporate headquarters is probably conservative. If you include packaging the cost of a soft drink is probably 90% overheads and 10% product. I’ve been involved in a few “restructures” and it’s amazing how much fat a corporate can trim whilst still providing the same products and/or services.

by Andrewj | 27th May 14, 10:19am 1401142752

How the Euro was (Really) Saved

http://www.prudentbear.com/2014/05/how-euro-was-really-saved.html#.U4O7…

by DFTBA | 27th May 14, 10:33am 1401143612

yes:

"Call me a nut, but I’m convinced the world is a much more dangerous place today than back in 2012. I don’t believe serious structural issues can be resolved by central bank monetary inflation. And I don’t view central bank market backstops as conducive to financial stability. Quite the opposite: increase the scope of a market backstop and you’ll correspondingly increase the size of the speculative Bubble. From Spiegel’s reporting, we now know that it was the U.S. and Italy that first pressed for a big (Fed-like) ECB/Eurozone financial backstop. Germany balked.

Now viewed as “one of the most successful monetary policies” ever, I believe the ECB backstop ensured only more dangerous excess. Financial asset mispricing has gone to greater extremes and speculative excesses have intensified. Underlying debt fundamentals have continued to deteriorate. Yet complacency is only more deeply entrenched. This creates latent financial and economic fragility. Meanwhile, global Bubbles stoke inequality and animosity around the world."

[...]

"There’s a far-reaching contradiction that I fear is going to come back to bite Europe. To “save” the euro, a small cadre of officials, including President Obama, had to impose a more unified and uniform Europe. More rules, restraints and operations dictated from Brussels and Frankfurt; less individuality and sovereignty for citizens, politicians and governments throughout a diverse and unsettled continent. Yet powerful secular forces – in Europe and globally – are pulling persistently in the exact opposite direction: less integration and less cooperation – deeper animosities and separatist proclivities. The perception is of a shrinking economic pie – an unjust “zero sum game” world – which dictates a more determined struggle to procure one’s share. The jury remains out on European integration and the euro currency experiment – awaiting the outcome of the global monetary experiment."

I have been followig the European elections with fascination. I agree with the last paragraph. There's mounting pressure on resources in Europe, nd people are digging in, re-trenching.

Everybody's getting ready for a fight - hence the swing to extreme right and left, eurosceptics who want to dismantle the gravy train that is the European Pariament.

We live in interesting times, indeed.

by Drawdown | 27th May 14, 10:52am 1401144758

The European Union was initially a good result for all involved; the manufacturing and exporting powers in the north enjoyed a lower currency with an immediate effect on their bottom line. The southern states/countries enjoyed cheap and easy access to abundant credit and cheap imports to spend it on following the disestablishment of trade barriers with fellow members. It is obvious, then and now, that these benefits would be perpetual for the northern states/countries but fleeting for the southern states now heavily indebted to the north. I believe a Mexican standoff will ensue; the southern states/countries know that de-coupling from the EU will be painful but no one is sure whether it will be more or less painful than remaining. One of the southern states will eventually de-couple and it will serve as an experiment/example.

by Andrewj | 27th May 14, 2:15pm 1401156951

Bass advised against shorting Chinese equity as a way to capitalize on his forecast. Instead, he said, investors should look at China’s trading partners – Australia, New Zealand and Brazil. Those countries will be forced to loosen their monetary policy, raising rates and creating carry-trade opportunities.

http://www.zerohedge.com/news/2014-05-26/kyle-bass-chinas-contraction-a…

by Andrewj | 27th May 14, 2:15pm 1401156953

http://www.zerohedge.com/news/2014-05-26/kyle-bass-chinas-contraction-a…