Euro Collapse a Distinct Possibility in 2017: ECB May Stop QE
U.S. President Donald Trump’s likely pick for the post of ambassador to the European Union (EU) had nothing positive to say about the euro’s prospects. He not only predicts a euro collapse; he expects the entire European Union project to crash.
The potential ambassador, Ted Malloch, offers a pessimistic outlook marked by a euro collapse. Malloch is not even sure if, over the next 12 to 18 months, the European Union will still exist in the way we know it today. (Source: “Euro could ‘collapse’ in next 18 months, warns the man tipped as Trump’s EU ambassador pick,” The Telegraph, January 26, 2017.)
Malloch, or Prof. Malloch rather, who taught at Oxford and Reading Universities, has a simple solution for the U.S. if—or rather when—the euro collapse becomes official. Malloch, who also predicted the Brexit, says that the U.K. and U.S. could reach a bilateral trade accord before the next round of eurozone elections.
The expectations are that the likely winners of those elections are all parties campaigning on a platform to leave the euro and the European Union altogether. In other words, 2017 is the year that the EU could come to an inglorious end, at least the EU as we know it.
Whereas predicting Brexit was dangerous for currency speculation, the euro offers more certainty. The U.K. left the European Union, but it was never even part of the European Monetary Union that led to the eurozone and the euro currency.
Given these gloomy EU predictions, if one were to translate Malloch’s eurozone concerns into investment advice, bearish speculation on the euro might be the solution. “The one thing I would do in 2017 is short the euro,” said Malloch, who last year had advocated a Brexit. (Source: Ibid.)
It’s Not Necessary to be an Oxford Professor to See that the Euro Has a Problem
For the euro, the writing has been on the wall, or rather on the TV, smartphone and laptop screens. In 2016, the European Union lost its first—and rather significant—member. In 2017, the euro currency could follow. But, if the euro falls, it ‘s difficult to see how the EU can survive.
The euro collapse, in fact, is not a possibility because of financial or economic reasons alone. The pressure is coming from all sides. One of these pressures is the accelerated phenomenon of illegal migration. Germany, the one country that can claim to have gained from the euro, has encouraged migration, offering to take in a million refugees in 2015.
The refugees have started to come, but they promptly caused several logistical and humanitarian headaches for the countries standing between Germany and the Middle East. This has forced Germany’s EU and eurozone partners (not all EU members use the euro currency) to manage a migration problem they neither expected nor wanted.
The subject of the eurozone collapse started to gain steam in the period of 2012–2015. Back then, it seemed like Greece was heading out the EU door. The so-called Grexit didn’t happen, even though anti-eurozone parties came to power in a tense election. The European Central Bank (ECB) feared the loss of Greece more than Germany wanted Greece out.
In the end, the ECB won the day, but Germany also took advantage of many bargain-basement deals on assets in Greece like hotels and airports. These are valuable in a country that still attracts millions of tourists.
Everybody Can See the Euro Collapse Coming
The main effect of the Grexit threat—and the Brexit reality—is that the subject of the eurozone collapse is out in the open. It’s no longer a taboo discussion topic. The trouble for investors, in fact, is that the current situation is akin to a “cry wolf” scenario. So often have pundits spoken of the end of the EU and the demise of the euro that few might pay attention on the eve of its actual occurrence.
The best advice for investors is to pay close attention to EU politics, the eurozone, the ECB, and ECB’s President Mario Draghi in 2017. The United States may be heading to a more isolationist course in 2017, but the world is still interconnected. What happens in Europe will no doubt affect what happens in Washington and Wall Street.
Simply put, the global financial establishment believes that the eurozone could collapse. At the very least, it believes that the eurozone and EU must change to reflect the political and economic union’s unraveling seams.
Mario Draghi famously said in July 2012 that the ECB would defend the euro, doing “whatever it takes.” Five years later, one Brexit, one near-Grexit and several other “exits” on the horizon, one wonders if the ECB remains so determined to save the euro. The smart money is on “no.”
This is because the eurozone leaders seem unable to confront the problems that the people of the eurozone face. So far, all efforts to keep the euro and the EU from eroding have focused on financial solutions. They have even given it the name “quantitative easing” (QE).
QE has not swept way Europeans’ general discontent. That’s why the people have been promoting the rise of populist movements in the continent. EU leaders are behaving exactly like the Democratic Party in the United States.
The generally centrist and center-left political parties, which have dominated European politics for decades, have failed to notice, or have ignored, the effects of a chronic economic slowdown in many of the key eurozone states in the wake of the 2007/2008 financial crisis.
They have failed to see the difficulties that so many Europeans have faced. Meanwhile, QE, or cheap money, has not helped. Many banks remain reluctant to lend, and governments are reluctant to spend on infrastructure and overall stimulus. For that, they rely on the ECB, using only financial tools of dubious efficacy.
Add to that the perception of a veritable invasion of migrants and refugees from land and sea. It’s easy to see, then, where the inward-looking right-wing populist movements—which could win elections in Holland, France, Italy, or even Germany in 2017—have found their fuel.
Meanwhile, the QE is having different effects in different places. In most of the EU, especially the southern members, like Spain, Italy, and Greece—but also France—a higher interest rate from the ECB would be unwelcome. These countries need a cheaper euro to stimulate exports and attract tourism.
Germany, meanwhile, has already sent signals that it’s grown tired of QE. It will likely try to expel some of the weaker euro states in 2017. There is a German election in September, and outgoing Chancellor Angela Merkel needs to show strength or risk losing the election. The German leader has lost consensus over her handling of the refugee/migrant situation.
Rising Inflation in Eurozone Will Force ECB to Cease QE
The December data on inflation in the eurozone shows that the European Union is heading in two different directions. This suggests that the ECB is failing. The problem is that, after years of stagnation, inflation in the euro countries has risen to 1.1%.
It is a mean between two extremes. Germany’s 1.7% inflation approaches the ECB’s target of two percent. But Italy, with 0.4%, still has an annual rate of -0.1%. This means it’s officially in deflation. The problem is that Germany cannot withstand the QE much longer.
Should the inflation rate continue to rise, the ECB will be pressed to stop its expansionary monetary policy. The first result would be for the ECB to halt its bond purchasing policy—which was to last for at least another 12 months—early. If the January and February inflation rates in Germany confirm the existence of actual inflation, the ECB could stop buying binds as early as next spring.
This will cause a debt crisis in the eurozone. If Greece was the epicenter of the last major eurozone crisis in 2015, Italy will spark a collapse of the euro in 2017. If the ECB stops buying bonds, (ends QE) the spread will skyrocket as in 2011. Italy’s risk premium, the spread between the 10-year Italian bond and the benchmark 10-year German bond (Bund), would soar.
That risk brought down the Silvio Berlusconi government in 2011. In practical terms, the higher the Italian Bond/Bund spread, the more interest that investors have to pay out for investments or loans in Italy. This makes Italy less competitive compared to other EU member states, causing severe damage to the economy.
In Italy, the higher interest rate would send a near-death-blow to major banks. In 2016, the Italian government had to recapitalize (nationalize) one of its largest banks: Banca Monte dei Paschi di Siena.
Unless European authorities do not address these concerns, along with immigration policy issues, and the excessive constraints on sovereignty from Brussels, the eurozone will collapse under its own bureaucratic weight.
Meanwhile, even Mario Draghi has started to lose confidence in the eurozone. The ECB governor admitted that the “accommodative” monetary policy would be tough to hold, given the rising inflation. But any country that leaves the EU must pay off its debts with the ECB.
Those countries like Italy, which are deeply indebted, will face problems if they stay, and face bigger problems if they leave. But Germany will put pressure on the whole EU system, regardless. This can only lead to a conflagration of the eurozone, and it could happen in 2017.