By
Kevin
Flynn
:
"
Draghi disappointed
," was the pronouncement from Bill Gross of Pimco bond fame. "
Draghi delivers
" rejoined the Daily Telegraph's veteran econ observer, Ambrose
Evans-Pritchard. The catch for market participants is that they
both may be right.
The markets have obviously taken the side of Mr. Gross for now.
No bond purchases, no refinancing operation, not even the rate cut
that many considered to be the absolute minimum necessity. European
equities plunged, Spanish and Italian bond yields soared, US
equities logged a third straight day of losses. What was European
Central Bank ((ECB)) president Mario Draghi thinking?
One possibility is that in reality, Mr. Draghi has successfully
nudged his agenda along. His comments focused on issues of monetary
transmission, which several commentators (including Mr.
Evans-Pritchard) took as signaling grounds for expanded bank
intervention, in particular bond purchases in the secondary market
for the purpose of capping sovereign yields and heading off further
crises.
In such a scenario, the conversation last weekend between Draghi
and Jens Weidmann, president of the notoriously reactionary German
central bank (Bundesbank) that is still fighting the ever-dangerous
rebirth of the hyperinflation aftermath of World War I some 90
years ago, rather than the continent's current slide into
recession, would have consisted of an agreement of broader action
on the grounds of correcting faulty transmission of monetary
policy.
In exchange for maneuvering room that
stays within the rules
, Draghi would thus agree to not lower rates, hold off on injecting
more money into the system and bide his time on bond purchases
until the formalities were observed. To wit, wait until yields
spiral to acceptably high levels (acceptable to the Bundesbank,
that is, as constituting an emergency), make Spain and Italy take
off their respective hats and beg for mercy, and above all, ignore
the equity markets entirely. It can be difficult for Americans to
understand the level of disdain Germans have for the markets and
how strongly they feel about not being dictated to by those stock
market swindlers, but it is stronger than how Red Sox fans feel
about the Yankees or Liverpool about Chelsea.
In sum, when bond markets are clearly failing and all have
followed the proper procedure,
Draghi may now have consent from Bonn to act as needed to preserve
monetary order and the euro.
August might then be a particularly tumultuous month, one that
first sees equities swoon as data continues to disappoint and bond
buyers shun paper from the southern rim of Europe, only to be
followed by a surprise cavalry charge from the ECB that re-ignites
equities and suitably punishes (in German eyes) reckless
speculators.
There is a hurdle in this line of thinking. The Bundesbank and
the Germans are sticklers for strict protocol, leaving open the
question of how narrow the opening will be for countries such as
Spain and Italy. Domestic political considerations in Germany
forbid any notion of its money being used to subsidize overpaid and
underproductive civil servants, or indeed any worker, particularly
those in industries that compete with German unions.
It may take formidably dire circumstances to extract concessions
from either side - in which case, the damage to the economy and/or
financial system could end up being up greater than anticipated by
the optimists
or
the European elites still insistent upon procedural considerations
being followed to the letter.
A less optimistic view is that Mr. Draghi and the Europeans are
still playing the same game of grand promises and minimalist action
that has characterized the last two years. The central bank
president talked a lot of game about the futility of doubting the
euro on Thursday, but did not go into detail about which countries
might still be using it a year from now. It's possible that the
current thinking from Germany is that the euro should be allowed to
evolve, with some making the cut and others not, with the result
being a better, more stable and above all more
suitable
eurozone.
It would be rash to overlook the degree of German complacency
about the budding storm. There is still
considerable opposition
to bond-buying within Germany, and even those not in outright
opposition often hold fast to imposing conditions difficult for any
current EU government to accept, especially if perceived as being
at the hands of the Germans. The recent European phenomenon of
collapsing governments is quite likely to repeat itself if certain
elements of German thinking manage to prevail in a crisis.
Despite the continual declines in recent German economic data,
the country is still enjoying a time of low unemployment and
recently increased salaries. It would hardly be the first country
to believe that the fires burning on the horizon were a spectacle
for the curious to watch at night, yet certainly not any threat to
its own comfortable, well-deserved existence.
Nor is the irony lost on this writer that while much of Germany
continues to obsess over the hyperinflation of the 1920s, the
phenomenon was given birth by the draconian conditions of the
Treaty of Versailles that wrecked the German economy and dug the
first holes of the Great Depression. Now many within Germany want
to take a similarly punitive approach with its supposed economic
allies.
Two things were still holding US markets together at Thursday's
close. The first was hopes for the jobs report on Friday, either
strong enough to beat the estimate, or weak enough to provoke the
Fed. The second was the rapidly growing belief that Wednesday's
FOMC statement laid the groundwork for near-certain accommodation
at the September meeting.
The worrisome part in all of the foregoing scenarios is the
seeming requirement that equities sell off first. There is
admittedly a lot of worry already priced into the stock market, but
there was a year ago at this time as well. It might not take much
in the way of a surprise to trigger a revisit to the year's
lows.
While we wait for damage great enough to permit a rescue
attempt, the European economy continues to weaken and the Germans
inhabit a land quite familiar to German philosophy:
cloudcuckooland
. It would be a bit more reassuring to see less complacency about
the potential damage of taking too long to act - the same kind of
complacency that convinced our own principals that the world would
be better off in the end without trying to rescue an undeserving,
troubled investment bank with insufficient moral grounds for
assistance.
The veterans of that crisis continue to remind their colleagues
across the pond of the need for urgency, but they don't seem to
heed us any more than we heeded them. Pass the dice and cross your
fingers might be the best advice we can give to all but the
hardiest.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
See also
USDJPY & AUDJPY: Everyone On One Side Of The
Boat
on seekingalpha.com