ECB shots all of the arrows in its quiver

Outlook:

The ECB shot all of the arrows in its quiver. Of the six measures, three are the biggies—the increase in the negative deposit rate by 10 bp to -0.40%, increasing the amount of QE from €60 to €80 billion per month, and adding investment grade corporate notes. This particular item was mentioned ahead of QE many months ago on the grounds there would not be enough qualifying sovereign paper, but a surprise all the same. As was doing both the deeper negative deposit rate AND raising the QE amount.

The surprising thing is that ahead of time, the market thought the ECB would hold some measures in reserve. This is why the euro did not move down and stay down. Yesterday’s weird move up implies some big players imagined they had inside information that the ECB would not be aggressive. If so, they got bamboozled, and if so, good for Draghi.

Now that the ECB has delivered, Draghi can say almost anything. Actions speak louder than words. Draghi’s words will be examined with no less vigor than before, however, because we really need to know what he thinks is next if these measures do not come up to snuff.

Let’s not go overboard projecting a one-way street for the euro from now on. For one thing, the new shorts will want to take profit the moment the opportunity arises. For another, we always get a pullback after a giant move, even if the “reasons” are a bit smelly. And finally, no currency stands alone. It’s always one of a pair and various factors can come along to push the dollar down, including the sentiment that the ECB action forces the Fed to delay its own move in the opposite direction. We don’t know if this is true, but we expect the idea to become prominent before the sun sets.

But while we wrestle with move and counter-move, remember one thing—a drop in the euro is worth more to the economy and thus to the ECB than a 10 bp cut in the deposit rate. The foreign exchange factor in trade and consumption, when trade is a high percentage of GDP, is very strong. We tend not to appreciate this point in the US. But it doesn’t escape Mr. Draghi. He can’t come right out and say a weaker euro is a central bank goal, let alone a top-tier goal, but it’s true all the same. In December when the ECB disappointed in the scope of QE, the euro rose. Draghi doesn’t make the same mistake twice.

Golly, we can’t wait to hear what else he has up his sleeve. What’s bigger than a bazooka? Google says it’s a rocket launcher, but that lacks onomatopoeia.

Tidbit: From an economist’s perspective, the most notable thing to come out of the Republican presidential nomination race is not the vulgarity of Mr. Trump, but rather how loudly his populist message is resounding. Populism takes many forms, including the commitment to bomb the hell out of ISIS and show the world who’s boss, but most prominently in the promise to stop this silly free-trade stuff.

Historically, it’s the Dems and their union supporters who try to slow down the free-trade movement. But the last time an anti-free trade movement had any traction was the campaign of third party candidate Ross Perot in 1992. He spoke of the “great sucking sound” of jobs being lost under NAFTA. Critics make fun of Perot but he was right. And Pres Clinton flipped the Dems to the free-trade side, which he was able to do in part because before him, Reagan had put a kill-shot into the union movement. When the census bureau started collecting union data in 1983, 20.1% of workers belonged to a union. By 2015, it was 14.8%, and the majority of those work in government. The private sector has only about 7% unionized workers.

Every economist on the planet will defend free trade as providing the most welfare for the greatest number of people on both sides the trade. Each side gets to show off its competitive advantage. Here’s the problem—the competitive advantage of the US lies in agriculture and in high-tech. High-tech includes Boeing’s planes as well as Microsoft and Apple. With the Chinese stealing every technological advance before it’s even completed, the only true competitive advantage the US has lies in producing food. Even then, sometimes the advantage comes only with cheating, like sugar subsidies.

We write about this every five years or so. We can never come up with any conclusion other than that free trade is not to the advantage of a large swathe of the US population, chiefly white factory workers but also the entire corporate bureaucracy that runs the factories. Arrogant Detroit managers come to mind. And this is the demographic that Trump and the other Republicans are now courting. The Dems traditionally promised to work for this demographic and did not deliver. To be fair, the Dems had every economist solidly against them. The economists are against Trump, too, but the anger and outrage are overwhelming the rational analysis. We’re just waiting for Trump to name Bill Clinton as the one who betrayed the working class. He will be right, too.

It remains to be seen whether the working class will defect in droves to the newly populist Republicans and actually elect this guy. But if they do, we can expect the US to start a trade war. Between the Dems and the newly pandering Plubs, Congress will have the votes to leave the WTO or flood it with complaints, impose tariffs and invent subsidies, and so on. Others will retaliate, for sure, including China possibly redenominating its FX reserves. A trade war is not a pretty thing. It would probably backfire in multiple ways not foreseen today.

Tidbit 2: Reuters reports that former BoF chief Noyer says Brexit would mean it’s unacceptable for London to remain the main trading center for the euro. “European authorities could not allow” London to remain the trading centre for the euro if Britain left the European Union.”

“The volume of euro-dollar trading alone was some $640 billion (£450.5 billion) a day in London last year and traders in the City financial district now buy and sell more than twice as many euros as the whole 19-member euro zone. ‘If Britain left the EU, the euro area authorities could no longer tolerate such a high proportion of financial activities involving their currency taking place abroad,’ Noyer wrote.”
What, exactly, does Noyer propose to do about it?

“The ECB has already attempted to require clearing houses that deal with large amounts of euro denominated securities, such as LCH.Clearnet in London, to shift to the euro zone, but this was rebuffed by the EU's top court in Luxembourg.” Noyer is talking through his hat. Beware all the high nattering nabobs who want to fix prices or otherwise tinker with markets. Market are awful, to be sure—irrational, over-reactive, sometime downright stupid—but as Churchill said of democracy, still better than any other system.