Are we about to get a new ”euro spasm”?
I hate to say it, but I fear that we are in for a new round of euro zone troubles. My key concern is that monetary conditions in the euro zone remains far to tight, which among other things is reflected in the continued very low level of inflation expectations in the euro zone. Hence, it is clear that the markets do not expect the ECB to deliver 2% inflation any time soon. As a consequence, nominal GDP growth also remains very weak across the euro zone. And with weak nominal GDP growth public finance concerns are again returning to the euro zone. This is from Reuters:
Spain plans to ask the European Commission for an extra year to meet its public deficit targets, El Pais reported on Sunday, after missing the mark with its 2015 deficit and raising the prospect of further spending cuts to narrow the budget gap. The country last month reported a 2015 deficit of 5 percent of economic output, one of the largest in Europe and above the EU-agreed target of 4.2 percent. To reduce that to the 2016 target of 2.8 percent of gross domestic product (GDP), the Spanish government will need to find about 23 billion euros ($25 billion) through tax increases or spending cuts. The economy ministry declined to comment on the newspaper report, which cited government sources as saying that acting Economy Minister Luis de Guindos would include revised economic projections in the stability program to be presented to Parliament on April 19.And Spain is not the only euro zone country with renewed budget concerns. Hence, on Friday Italy’s government cut it growth forecast for 2017 and increased it deficit forecast. Portugal is facing a similar problem – and things surely do not look well in Greece either. So soon public finances problem with be back on the agenda for the European markets, but it is important to realize that this to a very large extent is a result of overly tighten monetary conditions. As I have said over and over again – Europe’s “debt” crisis is really a nominal GDP crisis. With no nominal GDP growth there is no public revenue growth and public debt ratios will continue to increase. So why are we not seeing any NGDP growth in the euro zone? Overall I see four reasons:
- Global monetary conditions are tightening on the back of tightening of monetary conditions from the Fed and the PBoC.
- Regulatory overkill in the European banking sector – particularly the implementation of the Liquidity Coverage Ratio (LCR), which since mid-2014 has caused a sharp drop in the euro zone money multiplier, which effectively is a major tightening of monetary conditions in the euro zone.
- Continued fiscal austerity measures to meet EU demand is also adding to the negative aggregate demand pressure.
- And finally, the three factor above would not be important had the ECB been credibly committed to its 2% inflation target. However, has increasingly become clear that the ECB is very, very reluctant in implemented the needed massive quantitative easing warranted to offset the three negative factors described above (tighter global monetary conditions, regulatory overkill and fiscal austerity). Instead the ECB continues to fool around with odd credit policies and negative interest rates.
- Suspend the implementation across of the new Liquidity Coverage Ratio until we have seen at least 24 months of consecutive 4% nominal GDP growth in the euro zone. Presently the implementation of the LCR is killing the European money market, which eventually will be draining the overall European economy for liquidity.
- The ECB needs a firm commitment to increasing nominal GDP growth and to bring inflation expectations back to at least 2% on all relevant time horizons. Furthermore, the ECB need to strongly signal that the central bank will increase the euro zone money base to fully offset any negative impact on overall broad money growth from the massive tightening of banking regulation in Europe.