Friday, September 5, 2014

ECB in Fight to "Stave Off the Threat of Deflation"

More evidence that there is official concern that deflation is winning the battle. The ECB cuts interest rates and announces an asset buying program. Bloomberg and the NY Times both offer articles clearly stating that the concern is deflation and the move is an effort to "stave off the threat of deflation"

The ink barely dried on our recent post saying we need to keep an eye out for signs of official concern about a deflation event when the ECB makes their surprise announcement. Below are links to two articles and some quotes, then a few comments.

"Speculation that the European Central Bank would start buying debt in the year ahead had pushed the yield spread between U.S. 10-year Treasuries and German bunds toward a 15-year high and German 10-year yields to a record low of 0.866 percent last week. The ECB unexpectedly cut interest rates and pledged to buy asset-backed debt at today’s policy meeting to spur economic growth and stave off the threat of deflation."

"The ECB will start buying securitized debt and covered bonds, potentially easing the flow of bank funding for the region’s faltering economy."

"For Pacific Investment Management Co., which runs the world’s biggest bond fund, growth is weak enough that the next round of interest-rate increases will be less than usual."
No one’s talking about rate hikes in Europe for several years,” Richard Clarida, an official at Pimco, said yesterday on Bloomberg Television’s “Street Smart” program in New York. “Japan is still in an easing cycle. Globally, while the Fed and the Bank of England may start to move in 2015, it’s not going to be your father’s or your uncle’s rate-hike cycle.”
"Mario Draghi, the European Central Bank president, is reaching deep into his toolbox to revive the region’s moribund economy. He is cutting interest rates to the bone. He is charging banks even more to park their money. And he is using the central bank’s financial muscle to spur lending."
"The collective goal is to kick-start lending. In effect, the central bank will pump money into the financial system using the asset purchases, then charge banks if they park the money rather than put it to more productive use like loans to businesses or consumers."                     
"The most important effect of the central bank measures might be psychological. Thursday’s moves signaled that at least one European institution is doing all it can to avert the threat of deflation — the pernicious downward spiral of prices that often leads to high unemployment. Annual inflation in the eurozone was 0.3 percent in August, according to an official estimate, worrisomely below the central bank’s target of about 2 percent."
My added comments: We don't have to speculate any longer. The evidence is now overwhelming that there is concern at official levels about a deflation event. In the span of a little over a week we have an article in a CFR publication calling on Central Banks to give out free cash to try and stimulate the economy. The article admits QE has not worked to produce growth. Then we have the St. Louis Fed releasing a report that says Fed policy is not working to produce GDP growth with charts and graphs to prove it. Now we have the ECB with a surprise "shock and awe" announcement admitting that the Eurozone economy is struggling and facing the threat of deflation. Case Closed. There is official concern about a deflation event and the lack of velocity of money.
This supports Jim Rickards and others who agree with him that the policies are not working and that we would see new rounds of QE type programs. The ECB is so concerned they are going to charge banks for holding cash instead of injecting it into the economy to get velocity moving. All of this is exactly what Rickards and others predicted. And if the ECB is going to charge the banks to hold cash, why wouldn't the banks charge depositors to hold cash?
Recall the CNBC article on the St. Louis Fed that said people are "hoarding cash" and the velocity of money is too slow. Also that all the new money is creating no net GDP growth at all. All of this adds up to a clear message. There is fear that deflation is winning the battle. When you start charging people to hold cash things are not good. Anyone trying to save money is now viewed as someone who is "hoarding money".  This has a feel of desparation to it to use that kind of rhetoric and implement policy this drastic (charging banks to hold cash).
All the warning signs are clearly flashing. We need to watch like a hawk for any signs of a debt implosion or anything that might trigger a deflation event. The Central Banks are clearly running out of cards to play. At this point they might try anything. Even handing out free cash like the article in Foreign Affairs calls for. If we see that, we will know there are very serious concerns that deflation is overwhelming the Central Banks efforts. 
If so, how do they respond? With even more asset buying that they admit is not working? How do investors and the public react? Are they losing confidence and looking to save more cash in anticipation of possible hard times? Just the opposite of what the Central Banks want? Lots of questions, but few answers right now.

Update: Might as well add in this article: Top Fed Official says US Needs more Inflation
If what he says in this article is true, what is going to happen when all the rest of the FED quantitative easing dries up? What if interest rates start going up? He says he has no answer for that question and does not understand why the Fed is backing off. Will the Fed reverse course like Jim Rickards predicts by next year? And CNBC analyst Art Cashing piles on with this interview suggesting the FED may reverse course. Get your popcorn.

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