By Chris Berry (@cberry1)
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At this point, what could possibly be said about the economic health in the Euro Zone and the prospects for growth that hasn’t already been said? Realistically, the only question that has yet to be answered is how to ignite growth? This is a question you could ask about numerous economies around the world, but the structural challenges in the Euro Zone and the fact that you have a political union but not a financial one appear to be the reasons for what little growth actually exists.
With that in mind and with the European Central Bank (ECB) essentially out of ideas, the announcement of a quantitative easing (QE) program of €60 billion per month was likely the worst kept secret in finance. Specifically, this program will take the form of an asset purchase mechanism where the ECB will buy government bonds, private sector bonds, and debt securities of European institutions totaling €1.3 billion during the “life” of the program. Many would argue that the QE programs in Japan and the US have failed to achieve their objectives and this is why I mentioned Albert Einstein in the title of this note. He’s credited with saying that the definition of insanity is doing the same thing over and over and expecting a different result. Is anyone in the ECB familiar with this?
In just the month of January alone, central banks in Denmark, Turkey, India, Peru, and Canada have all lowered rates in an attempt to ignite growth. Additionally, the People’s Bank of China (PBOC), quietly injected USD $8 billion into the domestic banking system via a 7 day reverse repo lending facility. Clearly, the Swiss National Bank’s un-pegging the Franc from the Euro was the first domino to fall and other central banks around the world are positioning for a challenging way forward.
The QE program put forth by the ECB has many questioning its efficacy especially since QE programs in Japan and the US clearly haven’t achieved their objectives of a 2% inflation target or a new and healthier credit cycle. If anything, the QE program in the US was deflationary rather than the opposite as inflation and GDP growth remain well below long-run trends. It’s interesting to note that as the tapering of QE in the US continued throughout 2014, economic growth actually accelerated. It’s unclear if there is a direct relationship here, but it does make one wonder about the intentions and efficacy of QE-style programs.
It will also be interesting to see how market participants try and take advantage of the ECB QE program. With sovereign yields negative across much of the yield curve in the Euro Area (not just Switzerland and Germany) and the Euro currency at an 11 year low (see below), owning Euro-denominated assets seems to be an incredibly risky bet. Purchasing low or negative-yielding bonds is not a recipe for growth.
We will soon know if a Euro’s worth of QE is more potent than a Yen or US Dollar’s worth of QE. My sense is that it isn’t, which I think makes the case for considering hard assets (specifically gold and silver) as a hedge. I’ve often discussed the “financialization” of precious metals by gaining exposure through ETFs. The recent US Dollar strength has hurt commodities of all types in recent months, but it has paradoxically served to make them cheaper in other currencies like the Euro or the Loonie.
It appears that the recent strength in the USD price of gold and silver is due not to worries about inflation, but worries over the ability of central banks to get a handle on an increasingly unwieldy financial system.
While I don’t yet think this instability and recent higher bullion prices bodes well for the junior exploration sector, higher bullion prices in 2015 is something that I think we can start to consider for the first time in a long time. The optimal opportunities likely exist in owning the bullion or ETFs.
Ultimately, QE is a trap rather than a solution to a debt-ridden global economy unable to face the reality of deleveraging. Artificially low interest rates cloud the true price of risk/cost of capital and impede risk taking. Until the debts incurred in the lead up to and aftermath of the Great Recession are reckoned with, growth will suffer. This is why innovation and enhancing productivity are themes I’ve been so focused on in recent notes.
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