They don’t come any stupider than Madman Mario Draghi. Apparently attempting to ride out of Dodge in a burst of stimulative glory, he has essentially touched off a new, even more virulent race to the currency bottom.
And there is no doubt as to why the Eurozone wrecker-in-chief pushed the ECB’s deposit rate down a notch deeper into negative rate lunacy at -0.50%. They mean to slay the dragon of “low-flation”, it seems, even if it requires negative rates for, well, ever!
The Governing Council now expects the key ECB interest rates to remain at their present or lower levels ……until ……it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics.
Of course, one look at the relevant data and theory tells you the ECB doesn’t have a snowballs chance in the hot place of achieving the near 2.00% magic inflation marker by fiddling further with their subzero money market rates.
That’s because the leading edge of inflation is generated globally, not in the economic zone of one country or 19 countries. Beyond that, when the entire global convoy of central banks march to the same drummer of deeply lower for incessantly longer, the impact is deflationary.
Very simply, deeply sub-economic interest rates cause rampant over-investment and mal-investment because they lower the cost of capital to below corporate hurdle rates; and they also keep obsolete, high-cost and redundant capacity alive because zombie companies are never forced to liquidate and disappear.
Accordingly, global businesses are continuously battling with over-supplied markets. They are thereby incentivized to slash prices in order to move volumes at just above variable cost in order to generate “contribution margin” on their over-invested fixed capital and related costs.
In the long run, of course, rampant mal-investment and the throttling of Schumpeter’s law of “creative destruction” by central bank financial repression results in dead-weight economic losses and reduced levels of prosperity. But its immediate impact is to benefit the purchasing power of wages and the profit margins of companies able to purchase intermediate goods and components priced to sell at marginal cost.
That’s especially the case for the Eurozone economies, which benefit heavily from cheap consumer products and capital goods generated in East Asia and its supply chains. So why in the world are Draghi & Co. so fanatically determined to goose the realized inflation rates in the EU-19?
The answer is pure dumbkopf fetishism. They have embraced 2% inflation as essentially a religious canon and apparently palpitate with fear of wrath from the economic gods if the reported inflation metrics stray too far from the target.
But on the margin, the realized inflation rate as measured by the harmonized index of consumer prices is driven by global commodity price cycles. The black line in the chart below reflects a standard index of global energy, materials and other commodity prices on a year-over-year basis, and it fits like hand-in-glove the harmonized CPI (red line).
Here’s the thing. Whenever the harmonized CPI is temporarily driven toward the flat-line (or even a tad negative), it has been correlated with huge downward swings in global commodity prices. That is, low-flation is not a harbinger of the (falsely) dreaded “deflationary” bogeyman, but just the brute force of powerful commodity and industrial price oscillations on the measured consumer price basket.
For instance, after oil peaked at nearly $120 per barrel in mid-2014 and then crashed all the way back to $30 per barrel over the next 15 months, the harmonized CPI hit nearly 0.0% on a year-over-year basis in Q1 2015.
But you can bet your bottom dollar that this had nothing to do with crashing prices and wages in the EU-19 economies per se. What was actually happening during Q1 2015 is that the global commodity index had plunged by –32% from its prior year level, dragging the CPI down with it.
Needless to say, at the time neither global commodities nor Eurozone prices continued to sink into some economic black hole of deflation. Like all standard commodity cycles, which are heavily driven by producer stocking/ destocking swings as well as changing supply/demand balances, the global commodity index was soaring upwards by 30% year/year by late 2016, pulling the harmonized CPI along with it.
At the present time, they are gumming again about an inflation shortfall—with the harmonized CPI up by “only” 1.3% versus prior year in Q2 2019.
Then again, the commodity index is now down -8.5% from last year—so its not even a matter of “go figure”. It’s just the cycle, stupid!
In short, the ship of fools on the ECB governing council are looking a gift horse in the mouth. Lower inflation is an unequivocal benefit to their debt and socialism ridden domestic economies, but like King Canute, they are shouting at the globally originated inflationary waves which they—-like every other single economy central bank—are powerless to do much about.
The more subtle argument made for fighting low-flation with easier money is that the policy target is actually not really inflation per se; inflation is held to be a proxy for underlying real growth and job generation. Ipso facto, keep inflation slouching toward the magic 2% and you will accomplish the real objective, which is enhanced growth of output, jobs and incomes.
Except you won’t!
Here is our same red line (inflation) and black line chart—except real GDP growth is substituted for the global commodity index. Alas, the nearly perfect correlation in the above charts totally disappears in the one below.
For instance, when real GDP growth hit a respectable 2.45% versus prior year in Q1 2016, the harmonized CPI was exactly 0.05% versus Q2 2015.
Not only that. It should also be noted that real GDP growth is again sinking among the EU-19 economies—not withstanding 4 years of subzero interest rates and nearly $3 trillion of bond purchases by the ECB since 2015.
That is to say: All that money-pumping and you get 1% to show for it?
Unfortunately, what you also get is the attention of the monetary moron in the Oval Office, who wasted no time tweeting upon Draghi’s final act of madness: