The ECB is about to embark on a massive QE program.
It’s the worst kept secret in markets with French President Francois Hollande telling the Wall Street Journal in an interview overnight that it’s a fait accompli.
While European stocks have risen in the hope that ECB QE will drive stocks even higher, Soc Gen’s Global Head of Economics, Michala Marcussen, has poured cold water on hopes that the ECB’s action, and those of other central banks – like the ones in India and Denmark – trying to kick-start their economies will work.
Marcussen argues the transmission mechanism between policy action and economic results are broken and that the world risks a downward economic feedback loop.
Ordinarily, low commodity prices, low interest rates and weak currencies (for those that have them) should boost growth, but we believe that “price” multipliers are today impaired. In the race to export deflation, we note that the nominal dollar economy is shrinking. Ironically, this could add to the deflationary impulse, risking new declines in commodity prices and interest rates, and weighing on dollar earnings.
Price multipliers are broken Marcussen says, and citing modelling work done by her economics team at Soc Gen along with models run by the OECD, argues global grwoth should have been much stronger now than it is.
All else being equal, the drop in G3 interest rates over recent years should, by now, have delivered a significant boost to world GDP. In Japan, the 40% trade weighted yen depreciation over the past two years should have yielded a GDP boost of around 2%. In the euro area, the 7% euro depreciation since the summer should have lifted GDP expectations by an accumulated 1.2pp out to 2017, given the move is durable. And, finally, the decline in oil futures prices (applying the IMF assumption that 60% hereof is supply driven) should have raised global GDP forecasts by an accumulated 1% by 2017.
That’s the conventional wisdom and many commentators and policy makers continue to assert that growth will flow from lower rates and the big drop in oil.
But it hasn’t worked yet and Marcussen offers eight reasons why it may not work on a global basis, most of which are also applicable to Australia and hopes that a lower Aussie dollar and RBA rate cuts will lift the local economy out of the doldrums.
Here is Marcussen’s 8 reason why the price multipliers are impaired.
- A high debt stock: Marcussen says that, “top of the list is the still large stock of debt observed in several major economies, on both public and private balance sheets.”
She says that, “most macro econometric models only reflect existing debt stock through the debt servicing channel. In a low interest rate environment, this may understate the impact of a high debt stock.”
That is the focus on paying down debt not just servicing it.
- Tighter financial regulation: “To the extent that tighter financial regulation limits the risk of future bubbles, it can deliver significant value added. In the transition to a new regime, however, it comes with a cost and may structurally lower credit multipliers.”
- Balance sheets under pressure … energy producers, Russia, CHF borrowers, USD borrowers: Marcussen says that big swings in commodity prices and exchange rates add balance sheet stress across a much larger swathe of companies than those just impacted by the moves in energy and other commodity prices.
Essentially she says uncertainty, and price shocks, are bad for balance sheets
- Balance sheet protection and share price focus: Business managers are managing to protect share prices and balance sheets not capture market shares, Marcussen suggests. This means gains are retained and do not filter onto customers, eroding the multiplier impact of the falls in prices.
- Lack of economic flexibility: “Economies with flexible structures have clearly been rewarded post-crisis … just contrast what has happened in the US and UK, on the one hand, with what has happened in the euro area and Japan, on the other.”
Australia is trying for a UK, USA result with a lower Aussie dollar.
- A deflationary drag from China: “To our minds, China is today exerting a deflationary drag on the global economy as the world’s second largest economy gradually unwinds excess productive capacity.”
- Unexpected second round effects on wage: Marcussen says that the impact of fuel price falls and falling prices is that “employers justify lower wage outcomes by the lack of inflation. Low productivity gains further heighten this risk.”
This directly feeds back into confidence and consumption and is a big risk for Australia in 2015.
- Demographics: “Finally, ageing populations. This can have an impact on wage outcomes if older workers prefer the security of a long held job over the prospect of wage gains (this is especially likely to when employment protection is high). Furthermore, concerns of low returns may trigger higher savings (as opposed to more borrowing) as retirement approaches, and all the more if governments are eroding past pension promises.”
It all adds up to a continued experiment from global central banks and policy makers which so far has only gained traction in the US, and to a lesser extent the UK.
If Soc Gen is right and the multipliers are broken across the globe then the economic future is going to continue to be much weaker than is currently forecast.
The worst part of that is its a precondition for the continuation of the very negative feedback loop Soc Gen has identified.
Indeed Marcussen says that, “As the ECB prepares to race faster in a bid to export deflation, the risk is that the dollar economy (world GDP measured in US dollars) will shrink further. The dollar economy is down by just over 5% since July, marking a loss of just over $4tn in nominal terms. The last sharp contraction of the dollar economy took place in 2008. Back then the economy shrank by just over $7tn, marking a loss in excess of 10%.”
In the end, low growth, low price rises and deflation, central bankers losing an ability to achieve their goals could, “exacerbate the market phenomena that have investors on edge” Marcussen says.
Welcome to 2015.