Germany is just a distraction from the real story

Who cares who replaces Angela Merkel? But the likely inability of the ECB to address the consequences of monetary experimentation and inflation in coming years could cause Germany’s coming generation of bland political nobodies to be superseded by something more populist and chaotic, creating all kinds of problems for Yoorp.

Blain’s Morning Porridge –  Sept 6th 2021: Germany is just a distraction from the real story

“The bloody uproar of war is over; let’s enjoy the carnival of inflation.”

This morning: Who cares who replaces Angela Merkel? But the likely inability of the ECB to address the consequences of monetary experimentation and inflation in coming years could cause Germany’s coming generation of bland political nobodies to be superseded by something more populist and chaotic, creating all kinds of problems for Yoorp.

Sorry about the late Morning Porridge. Yet again I find myself screaming abuse at Virgin Media – the worst company on the planet. I am so angry at the lack of any broadband this morning I have the proverbial pain in my chest. If a Virgin employee showed up now – we are now up to 17 pointless, fixed-nothing, site visits – I will end up in jail. So please bear with this morning as I try to distract my fury at Virgin Media’s Internet Non-Service failing for a about the billionth time by starting this morning’s porridge in a more lyrical mode….

Calm… Small voice of calm.

Its early September and it feels like summer finally arrived here on the South Coast of Blighty. But it’s already autumnal – the sky is a faded shade of blue, backberries are ripening, curlews are on the river, and the thin mist makes it indescribably beautiful.  It’s a heartening change from the months of grey claggy skies that went before. I wish I’d brought my phone so I could have photographed the scene as puppy-dog took me for my early morning perambulation.

Our lockdown puppy, Dinner Jacket Wriggle-bottom – DeeJay for short, is shaping up to be one of the finest economic minds of our generation. Each morning, before readers get the Morning Porridge, DeeJay and I discuss the events moving markets. His thinking on central bank monetary creation and debt is fascinating – he just shrugs and chases a squirrel or two as if it doesn’t really matter what the consequences may be.

To be fair, most DeeJay policies are demand side driven – encouraging cute puppies to beg food from the table, tax-breaks for doggie-treat makers, and boosting manufacturing capacity in the easily digested tennis ball sector.

He does have some staggering insights: the other day he was staring at his reflection in the mirror and turned round to me and asked: “Dad, when did we get a puppy?” Fair comment. He observed, and came to a conclusion. It’s probably worth a seat on the MPC or the ECB’s rate-setting team at some point.

This morning we were discussing Germany. I asked him what he thought of this great quote I was sent last week: “Whoever thinks that by voting for either SPD or CSU they are choosing a political profile is suffering from delusion. This is a contest between a blancmange and bath sponge.

He shrugged – DeeJay is good at shrugging – and asked why I worry about who replaces Angela Merkel? “Really? Who cares..” he gently woofed. “It will be some German” he insightfully concluded and returned to the main business of the day – ravaging a stick.

Rather than be distracted by the long term dull, boring, predictably bland non-excitement that is Germany – which was, is, and will be… Germany – Deejay reckons we should really be thinking about what all the news coverage on which Turnip replaces a Cabbage is distracting us from.

There is more to Europe than just Germany, he expanded. German maybe the economic powerhouse of Europe, but just because Kelty Hearts are top of the Scottish 2nd League, (which is actually the 4th ranking division in a nation with only 2 football teams anyone else has heard of), doesn’t mean they are contenders for the European Cup.

But, actually, Germany does matter.

They might say No.

Germans are very good Europeans. Germany has toed the ECB line on “whatever-it-takes” pandemic response policies – but whether that continues is not a given if the structure of German politics changes post Merkel. Consider what happened in the UK. For many decades our politics were stable; Thatcher, Major, Blair, and Brown. Look at how quickly it turned chaotic, and the talent pool dried up, Labour imploded and we hoped and prayed Boris Johnson was a solution. (Hope is never a good strategy.)

German politicians have been very good Europeans since the 1950s. Germany’s next generation of faceless blobs may exude EU orthodoxy today, but what will follow them? What if Germany heads down the same populist road as the UK? (I don’t expect a Grexit – the Germans are not stupid, and the EU has been extremely good for them – but they could create all kinds of long-term economic crisis if they demand a change in the rules.)

What if next generation take note of where the ECB has got them and starts asking pointed questions? And, what if that is happening just as the ECB faces an inevitable crisis of consequence? Its already happening.

Jens Weidmann, the arch-Bundesbanker, has been publically muted in his criticism of how the ECB has mutualised European funding through its “social” EU bond programme. Effectively, these bond programme allows the EU to fund member nations, giving them defacto control of fiscal spending. That is not what Germany and the Bundesbank thought they were signing up to.

In order to placate the Germans about the consequence of these programmes, and backstopping easy money, the ECB is allowing noises off about ending, or scaling back its PEPP (Pandemic Emergency QE) bond buying binge later this week. That might just reassure whoever replaces Mutti that German workers aren’t paying Italian pensions (er… they are.).

The tipping point for Germany may be how the ECB reacts to inflation. August’s 3% European inflation print was a shock. Germans are acutely sensitive to inflation. For historical reasons involving Printing Presses, War Reparations and Wheelbarrows, Germans require new trousers whenever inflation is mentioned in polite company. Buy trouser futures now – inflation is coming.

The problem for the ECB is that ending PEPP (currently running at €80 bln of debt each month) won’t address inflation. The 3% EU inflation spike is largely supply side generated – a consequence of the pandemic and supply chain disruption. German automakers – a critical bough of the economy are warning Chip disruptions could last 2 years. Labour shortages in logistics and hospitality are fuelling wage demands across Yoorp. Supply side blockages occurring just as post pandemic populations start spending again will generate real inflation.

The past 6 years of ECB QE, and previous do-whatever-it-takes measures by the ECB to rescue banks and EU economies has done critical genetic damage to the functioning of the European economy. Rather than supporting growth, its policies have institutionalised low growth by dampening entrepreneurial spirits and business evolution, supported lacklustre companies surviving and strengthened stultifying bureaucracy draining the life out of the European economy.

Cheap money did not spur a massive European growth spurt, but kept Italy, Spain, Greece et al afloat and saved them from economic calamity, and worse from an EU perspective; exiting the Euro. All that distorting monetary creation in financial assets is now being exported into real economy as inflation as economies reopen.

The traditional response to inflation is to raise rates to limit monetary creation (via lending) and slowing the velocity of money in the economy. Yeah… How would that work in Europe? Not well. Raising interest rates will impact the rest of Europe catastrophically. This week expect the ECB to make encouraging forecasts about how the August inflation print was an aberration, a spike that will be quickly reversed. Their forecasts for next year will be sub the 2% target.

Europe is not Germany. If you want to measure the risks inherent in a political shift in Germany – look at how the rest of Europe is doing. Growth may be recovering, but how much of that is just spending repressed by the pandemic… something of a dead cat economic bounce? Look at the charts and European economies are almost as active as they were pre-pandemic – when they were hardly thriving. When ECB economists are highlighting 50% hotel occupancy in Spanish resorts as a signal of economic strength… be concerned..

No Five Things to read this morning as I am writing this morning’s porridge on a bench where I can get a decent signal…

Out of time, patience and still got the day job to do…

Bill Blain

Strategist, Shard Capital