Inflation returns to the US, ECB trapped: but what strategy does Mario Draghi have in mind?
Our hour of air is about to end. With end-lockdown inflation coming from the United States, the Germans are preparing battle to end the ECB's QE / PEPP. But it would be unsustainable for Italian government bonds. Faced with such a risk, Draghi's reaction seems to be not to hasten the end of the lockdown and to insist on monetizing the debt, in spite of the Treaties and the German Nein. Will the US inflationary revolution bring monetary relations between Germany and Italy back to 40 years ago?
In the United States, as we explained yesterday in Atlantico Quotidiano , government bond rates are rising, in anticipation of inflation that could result from the combination of both extremely expansive monetary and fiscal policies. And in the Eurozone?
The classic inflation – It is easy to say about fiscal policy. The Recovery Fund is a small thing (for Italy, the misery of 69 billion in so – called non -repayable transfers , by 2026). Even adding it in full to national stimuli, the sum would be half of the American one. National ratifications are proceeding slowly and Germany will pass a law that reserves the right of veto on the appropriations imposed on Conte last July for the Bundestag. A mythical federal budget is prevented by the current Treaties . The reform of the Stability Pact is postponed until after the enthronement of the new German chancellor . The monetary financing by the ECB is destined to end, says Bundesbank president Weidmann, "even if the financing costs for highly indebted states will increase", because "capital markets must regulate public finances".
As for monetary policy, what the US central bank (Fed) is doing is based on a reinterpretation of its three objectives (maximum employment, stable prices, moderate long-term interest rates). On the contrary, the ECB does not have the same luck: “the main objective is to maintain price stability ”. Thus, some have sought the loophole of secondary objectives: "without prejudice to the objective of price stability … supports general economic policies in the Union" ("without prejudice" in the French text , "as long as this is possible without prejudice " in the German text ). Unfortunately, the secondary objectives aim at “the sustainable development of Europe… based on price stability ”, in case the concept of the main objective was not clear enough. And there is no one who does not see how any expansive policy is inflationary, as opposed to the mythological reforms (work, pensions, …), which are all deflationary and never aim for maximum employment, except in the models of some economists, dreamlike and of a very long period. In this sense, the willing participation of the ECB in the Troika that imposed the reforms , for example on Greece, is perfectly consistent with the Treaties: a sufficient warning, we believe, to anyone who wants to use the loophole of secondary objectives to emulate the Americans.
In short, it is no coincidence that the Eurozone has fallen into deflation three times in the last 11 years and that, therefore, the ECB has become the least credible central bank in the world: under current Treaties, the Eurozone is structurally incapable of generating inflation.
Inflation from the end of lockdown – Yet, the increase in American rates has begun to be transmitted to the Eurozone, due to a phenomenon of emulation and arbitrage, called contagion ( contagion or spillover ). Upon hearing the news, Weidmann rushed to describe it as irrelevant. He puts forward two arguments . (1) The hikes in market rates depend on an improvement in the economic scenario and not on a rise in inflation expectations. Observation also made by the Dutch governor Knot and subtle, as what we are witnessing is certainly an increase in inflation expectations, but by the markets, probably not yet by the oxen park (the great audience of producers and consumers), that he will notice when he sees retail prices rise (prices in supermarkets, for example, which move with a certain delay compared to the price of ethylene, from which packaging plastics are derived). (2) The second argument is the usual juridical one : the prohibition of monetary financing to governments and the duty to resume the reduction of public debts.
What is striking is the particular emphasis placed on the first topic, that of inflation. This was the case in the early years of his Bundesbank presidency, in 2011-2012, when inflation was actually picking up. Then, however, inflation collapsed and Weidmann began to speak more widely about legal arguments (he did so again last October ), as well as to whine for poor German savers penalized by low rates. Today, if he believes that he is returning to focus on the subject of inflation, it means that he judges that inflation is indeed returning.
His conviction is based neither on optimistic forecasts of recovery, nor on the increase in the cost of raw materials (a classic inflation engine), nor on the jump in German inflation in January (from -0.7 per cent in December +1.5 percent). His conviction is based on the end of the lockdown ("many will be led to go to beer gardens and restaurants, a similar reasoning applies, for example, to travel"), which financially can be interpreted as a form of savings forced (the reciprocal of pent-up demand , repressed demand), as well as destroying the supply capacity of entire sectors (an aspect on which Dragoni focuses). Of course, the lockdown still lasts and, on vaccines, the Eurozone is in solar delay, but it is also true that, sooner or later, the delay will be bridged and, then, we will see the release of forced savings , quantified by Jörg Krämer , head Commerzbank economist, in "over 10 per cent, almost the highest value since the founding of the monetary union, too much money goes into circulation, inflation potential is built".
Many analysts now see German inflation above 3 percent by the end of the year ( Commerzbank itself, ING , IfW , IMK ,…). Of course, the latter add that it would be a flare-up, but what matters is how it will be interpreted: Lagarde will speak of a transitory phenomenon (Visco has already said, “the increase in inflation will not be lasting”), but what will Weidmann say?
German attack – Well, Weidmann decided to ride the tiger and, instead of reassuring the good German bourgeois and workers, he used unequivocal words to incite them: "the inflation rate will continue to rise again, towards the end of the year the inflation rate in Germany it should be over 3 per cent ”. The best way to attract the attention of the ox park and anchor its inflation expectations to those of the markets. After such a declaration, what wage increase should the German trade union ask for? All the more so after Berlin did what even Washington avoided doing: raise the minimum wage , starting January 1, 2021? At least 3 percent, of course.
In short, Weidmann is calling for a wage increase in Germany. And why? Well because, he says, "inflation rates will begin to rise in a truly sustainable way, only if wages also increase", that is, an increase in wages in Germany will be an inflationary signal that the ECB will struggle to ignore. In short, Weidmann prepares a battle on the ground of inflation from the end of lockdown : he wants the ECB to exchange it for classic inflation and act accordingly, putting an end to the purchase programs (PEPP and QE) and to negative official rates.
ECB trapped – This creates a big problem for the ECB, which is called the real interest rate , that is, the difference between nominal rates and inflation. If nominal interest rates follow US rates, while eurozone inflation remains steady, then eurozone real interest rates would rise. That is, the opposite of what happens in the United States. With a deflationary effect multiplied by the appreciation, which would ensue, of the Euro against the dollar, which worries some within the ECB but not Weidmann.
Faced with all this, Lagarde has defined the higher market rates as unwarranted , unjustified and repeats to exhaustion (lately even with a rhyme ), which will maintain "favorable financing conditions until the end of the pandemic". But it is not clear what the latter expression means, nor how the ECB could do it. In theory, the ECB has two lines of defense: (1) the PEEP. He indicated that he did not want to raise it further, with the approval of Weidmann who would allow at most to use its flexibility (i.e. buy more assets for only a few months) without increasing the overall volume. Even if it were to increase it, the effect could only be limited, because Lagarde has explicitly linked the duration of the PEEP to the effects of Covid and the end of the lockdown is approaching. (2) The QE. Consequently, it was decided to increase the QE, the duration of which is not linked to Covid . And this is why Weidmann warned: "As soon as it is foreseeable that we will reach the inflation rate that we have set as our goal, it is important that the Governing Council of the ECB promptly withdraw its very expansive monetary policy", even if it is about inflation from the end of lockdown . He also sent a concrete signal by canceling, for this year at least, that form of money creation which are the annual dividends paid by the Bundesbank to the German government.
This being the case, vaccinations will trigger end-of- lockdown inflation which, in turn, will trigger the end of PEEP (and perhaps QE as well) which, in turn, will trigger the BTP crisis. In March we wrote that the ECB had granted us the hour of air. Here, the hour of air is about to end.
Italian tactics – For Italy (and the Latin country) the doors of Gehenna are reopening. Draghi cannot fail to know that the BTP (and the Oat and the Bonos ) would not hold up without the purchases of the ECB. Draghi is a banker. And what can be the reaction of a banker, in the face of such a risk, triggered by inflation from the end of the lockdown ? Well, of course, it doesn't hasten the end of the lockdown . So that no misunderstandings arise, he sent on the Italian member of the ECB Council, Panetta , to make a speech so explicit that it is not believed: yes, there are vaccines, but we are so slow to inoculate them and then there are the terrible variants of the virus; yes , there is forced saving, but only the old have it; yes, we will reopen something, but not travel and tourism… so there is no inflation and there won't be. Draghi himself, on Monday, listed the "many people suffering from the economic crisis, who risk losing their jobs", and then hissed: "we are only at the beginning".
What to think of 3 million vaccines in refrigerators? And how to judge the vaccination plan, as fast as Fregoli to change, but not to be implemented ( up to 13 months , but only if double or triple the daily vaccinations were made compared to today)? And how can we forget the rivers of words, by Draghi dedicated to students in his Rimini speech ? When he came to the government, he prevented them from accessing schools. And what about the promises Draghi made to businesses in his March FT article ? On the first day of his government, he ruined the mountain, then what remains of the bars and restaurants, tomorrow also most of the shops. All of them, we would not like him to consider them as collateral victims of a war greater than themselves.
In any case, Weidmann now knows that, even if he has succeeded in raising end- lockdown inflation in Germany (and perhaps even in the Germanic country), this will be offset by the ugly depression and deflation in Italy and in the Latin country. In other words, until after Germany leaves, we have to sit down, depressed beyond measure. And the war continues.
Italian strategy – What war? Panetta continues, (1) fiscal policies must "remain expansionary in 2021" and this is possible thanks to "the commitment of the ECB", which must continue (and many greetings to the Recovery Fund which "is aimed at financing reforms"). (2) Last time, after 2008, "domestic demand growth had been contained for too long", but this time it is different: we cannot, again, "get trapped in a context of low inflation, stunted growth and high unemployment ”, but we must continue“ until inflation reaches the 2% target on a lasting basis, in a context of high growth and rising employment ”. (3) To combat contagion from the United States, which raises real rates, the ECB must "anchor nominal yields" ( yield curve control ), ergo "define the area in which yields are located that it considers adequate, decide on its purchases in line with this objective and be ready to intervene to the extent necessary ", that is, to a potentially unlimited extent. Consistently, not only must QE continue and official rates possibly lower, but also “there is no reason to hesitate to increase the volume of purchases and to spend the entire PEEP budget – or even more, if necessary”.
In short, Draghi makes Panetta ask for nothing less than: the monetization of the debt, the oblivion of the 2 per cent target, the unlimited purchase of government bonds. In other words, copy what the Fed is doing: the American Revolution. All of this is contrary to the current European Treaties. Ergo, a reform of the Treaties would be indispensable. But such a reform is impossible because, frankly, there is no way for Germany to accept it: following the revolutionary announcement in August by the Fed, Weidmann spent heavy words against average inflation targeting , against the maximum employment mandate. , against the revision of the 2 per cent target, against monetary financing, against the control of the yield curve, that is, the unlimited purchase of government bonds. Nein means Nein .
The Weapon-End-of-the-World – Could Draghi not have foreseen it? No. So how do you expect to react? It may be that he mentioned it to the Senate , where he called for "expansive monetary and fiscal policies", and then defined the Euro as "irreversible". It seems to us to mean that, in the absence of expansive monetary and fiscal policies, the Euro would no longer be irreversible. This is the end-of-the-world weapon . It is true that Draghi has not yet shown that he can really operate it. It could be an artifice, a deception of the poor sovereignists, yet another mockery against the Italians. But even no.
To understand this, it is necessary to go back to before the Euro, before Mitterand and Reagan even. At the beginning of 1980, Mario Monti and Pier Luigi Gilibert explained that, even if the United States had become inflationary, Germany persisted tenaciously deflationary, in the sense of systematically accepting the revaluation of its own currency, as a price in order not to inflate itself. With an intransigence "which has found ample justification in thirty years of uninterrupted prosperity and has been continually influenced by a profound aversion to any sign of monetary degradation and is, without a doubt, the result of Germany's rise to the rank of industrial giant" . However, as the cost in terms of international trade of continuous revaluations was high, Berlin had ensured that a semi-fixed exchange rate system (the European Monetary System , or EMS) was built, through which it was granted, to her alone, “The possibility of pursuing independent policies” and which, therefore, served her as a means to “create a climate more favorable to the pursuit of her own deflationary objectives”.
Monti and Gilibert viewed this diktat with favor, because they also wanted Italy to follow deflationist policies, with the macabre taste that has never failed the former. On the contrary, among the other economists, those with a minimum of empathy for their compatriots, not many bet that the thing would be standing: Italy had already emerged from the previous attempt in 1972 (the monetary snake ), because it had preferred to remain pegged to the dollar. But, since August 1979, Paul Volcker had taken office at the Fed, who had reversed the direction of American monetary policy, furiously raising rates to the high of April 1980. Thus, the United States too became deflationary and the European thing. he could more or less stand for the next 40 years.
On August 27, 2020, something crucial may have changed. The current Fed chairman, Powell, has announced a revolution , in the literal sense of rotating around an axis and returning to the starting point: the one before Paul Volcker. If, as it seems, the facts follow the words, then the monetary relations between Germany and Italy (and, more generally, between the Germanic country and the Latin country) will also go back to 40 years ago. Again, Germany will have the choice: whether to become inflationary as well, or to remain deflationary but in all solitude. Just in case , God bless the United States of America.
The post Inflation returns to the US, ECB trapped: but what strategy does Mario Draghi have in mind? appeared first on Atlantico Quotidiano .
This is a machine translation from Italian language of a post published on Atlantico Quotidiano at the URL http://www.atlanticoquotidiano.it/quotidiano/negli-usa-torna-linflazione-bce-in-trappola-ma-che-strategia-ha-in-mente-mario-draghi/ on Thu, 11 Mar 2021 04:55:00 +0000.