Dovish Cooing from the Desolation of Draghi
As Reuters informs us, on the heels of Mr. Draghi’s somewhat “disappointing” attempt to assassinate the euro on occasion of the previous ECB meeting, the chief European printing press supervisor and certified monetary crank has decided to assure everyone of his ultra-dovish stance again on Thursday, by announcing that even more monetary insanity must be expected soon:
“Fading growth and inflation prospects will force the European Central Bank to review its policy stance in March, President Mario Draghi said on Thursday, a strong signal that more easing could be coming within months.”
The economy isn’t doing well? Let us set fire to the currency then, maybe that will help.
Still not enough inflation! Euro area M1, a close approximation of the true money supply. Currently this aggregate is growing at roughly 14% p.a. This is the actual rate of inflation. Rising consumer prices are merely one possible consequence of inflation, and not necessarily the most pernicious one. Moreover, consumer price inflation can often appear on the scene with a very long lag (many years) – click to enlarge.
Here are a few more excerpts from the Reuters article:
“Downside risks have increased again amid heightened uncertainty about emerging market economies’ growth prospects, volatility in financial and commodity markets, and geopolitical risks,” Draghi told a news conference. “We are not surrendering in front of these global factors.”
Dismissing concern that the ECB’s policy arsenal is all but empty, Draghi said: “We have the power and willingness and determination to act. There are no limits to how far we are willing to deploy our (monetary) instruments.”
Two things are worth noting regarding the sentence highlighted above: first of all, it is absolutely true that people who assert that central banks “have run out of bullets” are all wet. How can one possibly “run out” of something one can create from thin air at a keystroke?
Secondly, it shows that Draghi and the merry pranksters at the ECB Council are not only well aware that there are no theoretical and practical limits to their monetary depredations, but they seem fully prepared to “go the whole hog”.
Naturally, it once again remains unexplained just how the printing of additional money with the explicit goal of making life more expensive for consumers (while creating price distortions across the economy) is supposed to increase prosperity. Just reflect on the sheer absurdity of this notion for a moment.
One of the perverse outcomes of the ECB’s policies: Yields on Germany’s 2-year notes have declined to a negative 0.45% – lenders to the government are thus guaranteed to lose money. It is as if the arrow of time had been inverted or suspended – superficially it appears as tough the categories “sooner” and “later” no longer mean anything. An economy receiving such extremely distorted interest rate signals is bound to be hollowed out on a structural level. Eventually this will lead to another big bust – click to enlarge.
The Road to Economic Hell
These bureaucrats believe that the economy can be magically improved by creating additional money units ex nihilo, which is an eerie reminder of the French revolutionary assembly’s adventures in monetary debauchment in the late 18th century, an exercise that managed to drive France into a state of utter economic ruin.
The revolutionaries created and destroyed two currencies in a row within just a few years. As transcripts of their debates show, initially they had a few doubts as to the wisdom of this course. However, once they had embarked on it, they found it impossible to extricate themselves from the policy. In the end they went down the road to economic hell in ever greater strides. Mindless propaganda and State terror soon replaced reasoned debate.
Revolutionary funny money: in theory “backed” by land that was confiscated from the church, the initial issuance of this money gave the economy a brief “shot in the arm”, but as soon as the inflationary push ceased, the economy contracted again, falling into a worse state than before. And so they kept printing, until both the currency and the economy lay in utter ruins. And then they did it all over again with yet another currency (the mandat), because they thought they had “learned their lesson”!
The state of mind in which ECB council members find themselves these days appears eerily similar – there is no longer any room for doubt. Thursday’s intense cooing exercise reportedly met with the approval of the entire council:
Bolstering market hopes of more support, Draghi added that the ECB was unanimous in its communication stance on Thursday, a contrast to December when several notable hawks voted against policy easing.
Monetary lunacy seems to be a contagious disease.
Common Sense in Short Supply
Mr. Draghi inter alia provided journalists attending the press conference with this tidbit to explain why he thinks an inflationary policy must be pursued:
“Draghi also rejected arguments to simply look through the oil price shock, arguing low energy prices are likely to last, a risk that they would drag down the price of other goods and services, creating a downward spiral that is difficult to break.”
What arrant nonsense! In case you’re wondering dear readers, yes, this guy is actually an economist. We don’t know what it takes for someone to seriously believe that Europe, which is one of the world’s largest net oil importers and consumers, can possibly be hurt by a decline in oil prices. Imagine you’re in the Antarctic somewhere and there is Draghi berating you, trying to convince you that all this snow around you is actually not white, but black. That is how much sense this makes.
Moreover, the idea that “oil prices will drag down the prices of other goods and services and create a downward spiral in prices” flies into the face of even the most rudimentary economic logic. There are always some prices in the economy that are declining, while others are concurrently rising. In fact, this is precisely what can usually be observed in the early stages of an inflationary cycle – until the point in time when control is suddenly lost and trust in the currency evaporates.
Assume for argument’s sake that the demand for and supply of both money and goods remains unchanged in the aggregate. In that case, a decline in the price of one good must perforce be balanced by price increases elsewhere. This is incidentally what the data tend to show as well. There are of course no ceteris paribus conditions in the real world, but the trends in disaggregated price data are definitely in broad agreement with the above.
One only has to ask oneself a few questions, such as for instance: Is a decline in oil prices going to slow galloping price inflation in US education costs? Will it lower the ever growing electricity bills of hard-pressed German households? Will Martin Shkreli one day exclaim “Oh my God, crude oil is only at $28 per barrel! Quick, let’s halve the price of our latest orphan drug!”? – and so forth.
All one needs in order to realize that none of these things will ever happen is a modicum of common sense. Contrary to funny money, common sense is unfortunately not exactly abundant at central banks. In fact, it seems to be in extremely short supply.
Bizarre Deflation Paranoia
It is clear that the vast government and private sector debt-berg that has been created in the fiat money era is a powder keg waiting for a spark. The real reason why central bankers around the world are so eager to induce price inflation is that it is held that this will help to “inflate the debt away” – as if that could be done without serious economic consequences!
To the extent that this surreptitious theft of wealth succeeds, someone’s cash assets and income will of course be “inflated away” as well. Prudent savers end up being punished in favor of irresponsible debtors. Fiat money and credit expansion undermine the morals of the population, and this is one of the ways in which they work their evil.
The harmonized index of consumer prices in the euro area. Even in terms of official data consumer prices have done nothing but rise for decades. Can you spot the “deflation”? All that has happened is that the pace at which money loses its purchasing power has slowed down a bit recently (as you will see below, it nevertheless all depends on which prices one contemplates) – click to enlarge.
We keep hearing incessantly about the alleged threat of a “general downward spiral in prices”. The reality is this: Even electronic gadgets the prices of which used to steadily decline for decades are becoming more expensive in Europe since Draghi has decided to burn the euro.
Here is just one example we can cite from personal experience: “Evolver”, a desktop synthesizer built by Smith Instruments (which is by now a four or five years old model), could be bought for less than €500 two years ago. Today it costs €670, in other words, its price has increased by 34% (!). If memory serves, we have never before seen an increase in the prices of such items.
The decline in the euro’s external value represents a strictly temporary advantage for exporters (the advantage will be gone as soon as domestic prices have adjusted), to the vast detriment of all European consumers. In short, a tiny sector of the economy is artificially subsidized at the expense of everybody else. This is one of the so-called “successes” of the ECB’s inflationary policy.
Unsound Credit Still Clogs up the System
It is however clear that the credit and asset bubbles central banks all over the world have aided and abetted are continuing to take their toll. Aside from the collapse in commodity prices and EM currencies, Europe’s banking system seemingly remains on the brink of disaster. As we have pointed out late last year, euro area banks continue to sit on €1 trillion in dud loans (see “Europe’s Banks Still Drowning in Bad Loans” for details).
After Germany’s giant banking house Deutsche Bank reported a loss of nearly €7 billion, its stock has plunged to levels last seen at the height of the financial crisis. In Italy bank stocks have been in free-fall in recent days as well. Italy’s government is reportedly so hopelessly over-indebted, that it cannot even afford to set up a so-called “bad bank” (the balance sheets of Italian banks are marred by NPLs in excess of €200 billion).
“Bad bank” structures primarily serve as a means to distribute the losses of banks across a country’s entire population while in the process making them disappear from banking statistics. Insolvent zombie banks are given a second lease of life in this way. It is rightly feared that too many people might otherwise begin to wonder how the modern monetary and banking system actually works.
Specifically, they might begin to wonder just where their cash deposits and money savings actually are. Trust in the banking system hasn’t exactly improved in the wake of the adoption of the EU’s new “bail-in” regime. In principle there is of course absolutely nothing wrong with letting bank creditors take responsibility for risks they have taken voluntarily, but it seems likely that this law will sooner or later prove to be incompatible with fractional reserve banking.
A widespread recognition of how big systemic risk actually is would create quite a quandary for the authorities. If they once again react by trying to print their way out of the problem, Mr. Draghi’s dream of inducing a little bit of price inflation could quickly become an unmitigated nightmare.
We have said it before, but it needs to be said again: the lunatics are running the asylum. Central planning will always fail, simply because it is literally impossible. This has been known since the 1920s, but ever since they failed to disprove the argument, statists of all stripes have preferred to studiously ignore this fact. Most mainstream economists continue to pretend that economic laws simply don’t apply to price fixing by central banks.
Now that we have finally reached the point at which the planners feel compelled to impose negative interest rates, we are quite likely close to some sort of endgame. With such abject nonsense widely accepted as “normal” these days, it seems fair to assume that we are well past the point of no return.
Meanwhile, Mr. Draghi and his colleagues should ask themselves this: What precisely is even looser monetary policy supposed to achieve that the printing of €60 billion per month and a minus 30 basis points deposit rate couldn’t?
Charts by: BigCharts, ECB
Addendum: Mises on Credit Expansion and Inflation
Ludwig von Mises
Photo via Mises Institute
We leave you with a few words by Ludwig von Mises that pertain to the problems discussed above (these are all excerpted from Human Action – the headings have been added by us):
- Inflation is popular:
“The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the over-consumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers’ stone to make it last.”
- Money and money substitutes cannot replace real capital:
“However conditions may be, it is certain that no manipulations of the banks can provide the economic system with capital goods. What is needed for a sound expansion of production are additional capital goods, not money or fiduciary media. The boom is built on the sands of banknotes and deposits. It must collapse.”
- The accounting profits obtained in the inflationary boom are illusory – in reality, people consume their capital:
“It would be a serious blunder to neglect the fact that inflation also generates forces which tend toward capital consumption. One of its consequences is that it falsifies economic calculation and accounting. It produces the phenomenon of imaginary or apparent profits. If the annual depreciation quotas are determined in such a way as not to pay full regard to the fact that the replacement of worn-out equipment will require higher costs than the amount for which it was purchased in the past, they are obviously insufficient. If in selling inventories and products the whole difference between the price spent for their acquisition and the price realized in the sale is entered in the books as a surplus, the error is the same. If the rise in the prices of stocks and real estate is considered as a gain, the illusion is no less manifest. What makes people believe that inflation results in general prosperity is precisely such illusory gains. They feel lucky and become openhanded in spending and enjoying life. They embellish their homes, they build new mansions and patronize the entertainment business. In spending apparent gains, the fanciful result of false reckoning, they are consuming capital.”
- Saving is discouraged, extravagant spending encouraged; eventually, people realize they have to take action to save what they can:
“Finally, with the progress of inflation more and more people become aware of the fall in purchasing power. For those not personally engaged in business and not familiar with the conditions of the stock market, the main vehicle of saving is the accumulation of savings deposits, the purchase of bonds and life insurance. All such savings are prejudiced by inflation. Thus saving is discouraged and extravagance seems to he indicated. The ultimate reaction of the public, the “flight into real values,” is a desperate attempt to salvage some debris from the ruinous breakdown. It is, viewed from the angle of capital preservation, not a remedy, but merely a poor emergency measure.”
- The boom can be extended, but there is no way to make it last forever (let us call this a special warning to Draghi):
“The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.”
And that dear readers, is how it is.
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