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How Can a Single Interest Rate Serve 19 Widely Varying Eurozone Economies?

Let's discuss widely differing inflation within the Eurozone and how things have changed in the last year.
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CPI data from OECD, Chart by Mish

CPI data from OECD, Chart by Mish

The Eurozone consists of 19 countries: Belgium, Germany, Ireland, Spain, France, Italy, Luxembourg, the Netherlands, Austria, Portugal, Finland, Greece, Slovenia, Cyprus, Malta, Slovakia, Estonia, Latvia and Lithuania.

Given widely differing economies and rates of inflation it is impossible for the ECB to set an interest rates that serves every country that has adopted the Euro as its currency.

Eurozone CPI December 2020 to December 2021 Change

CPI data from OECD, Chart by Mish

CPI data from OECD, Chart by Mish

Highs and Lows 

  • In December of 2020 the CPI ranged from -2.32% in Greece to +1.14% in Austria
  • In December of 2021 the CPI ranged from +2.75% in France to +6.55% in Spain
  • The December 2020 the low-to-high spread was 3.46 percentage points
  • The December 2021 the low-to-high spread was 3.80 percentage points

ECB Interest Rates 

ECB Interest Rates chart from St. Louis Fed

ECB Interest Rates chart from St. Louis Fed

The ECB punishes banks and savers alike with Interest rates current at -0.50 percent. 

The ECB thought this would stimulate lending, but it didn't and won't. 

Effective Lower Bound (ELB)

At a certain point, reducing interest rates does not stimulate growth. It's not possible to know that point, but it for certain it is above zero. Thus the ECB's rate setting policy is a guaranteed loser.

For discussion of the ELB, please see In Search of the Effective Lower Bound

Negative Interest Rates Impossible Naturally

Negative interest rate cannot happen without central bank interventions. Negative rates imply things like it is better to have 99 cents ten years from now than a dollar today. 

That is logically impossible, yet here we are. 

Fed vs ECB

Whereas the Fed paid interest (free money) on QE deposits crammed down banks' throats, the ECB charged banks interest on QE crammed down their throats.

The Fed slowly recapitalized banks with free money but the ECB made banks' lives more difficult. 

As Long as It Takes 

Image from ECB press conference, annotations by Mish

Image from ECB press conference, annotations by Mish

In September 22, 2019 I wrote ECB's New Interest Rate Policy "As Long As It Takes" Huge Failure Already

"As Long As It Takes"

On the day the ECB announced the alleged stimulus, I commented ECB's Counterproductive QE: Whatever It Takes Morphs Into "As Long As It Takes"

How the heck did anyone think that lowering the rate from -0.40% to -0.50% would do anything?

It seems the ECB does not have a basic understanding of bank lending requirements.

Target 2 Imbalances 

Target 2 imbalances courtesy of ECB, annotations by Mish

Target 2 imbalances courtesy of ECB, annotations by Mish

The Target 2 Payment System is another fundamental flaw of the Eurozone.  Here is the latest Target 2 Report

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Target 2 is a real-time gross settlement system. It represents county-to-country claims and liabilities owed by one country to another. 

It is also a measure of capital flight. For example, if Greek citizens do not trust Greek banks, they may prefer to keep deposits in Germany.

Every Eurozone county has its own central bank. This would be like California, Illinois, Texas, etc. having their own central bank. 

The ECB says a euro is a euro, but if Italy, Greece, or Spain were ever to leave the Eurozone, we would instantaneously see the flaw in the system. 

Recall the capital controls the ECB forced on Greece and Cyprus. As it stands now, Germany is a creditor to the tune of  €1.26 trillion and growing. Spain and Italy are borrowers to the tune of €0.51 trillion and €0.59 trillion respectively.

The ECB has its own Target 2 imbalance as a result of its QE program. 

In theory, all of this debt is treated equal and can never be defaulted on. In practice, an economic crisis like that in Greece and Cyprus proves otherwise. 

Euro is Fundamentally Flawed

  • There is no single interest rate that can possibly serve Greece, Italy, Germany, and France, let along all 19 countries in the Eurozone. 
  • The Target 2 payment system that treats all debt alike exacerbates the problem. 

These two imbalances led to an Enormous Property Bubbles in Spain 

Spain may very well be back in another housing bubble and it tops the list at 6.55% inflation as of December 2021.

Meanwhile, Germany will do anything to keep exports flowing to both peripheral Europe, Russia, and China.  

The fundamental flaws of the Eurozone have not been fixed and there is roughly a zero chance they can be fixed.

To comingle debt, Germany would need to change its constitution and it would take a rules change in every country to agree to do so.

Every country, not just Germany would have to agree to these changes and that is the third fundamental flaw in the Eurozone. 

It's been 14 years since the last crisis, but nothing has been fixed in the Eurozone or the US. The US has enormous fiscal deficits with no end in sight.

What's Propping Up the US Dollar?

People often ask me "what is propping up the US dollar?" 

Those asking the question do not understand what's going on in Europe, Japan, or China. 

All the fiat currencies are flawed. 

There is competitive currency debasement by every central bank with negative interest rates in Europe and Japan, and an imploding property bubble in China.

There is one currency I do like: Got gold?

This post originated on MishTalk.Com.

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