In the red, white & blue

If you have to ride out an eco­nomic storm, the best place to do it is the US

The Daily Telegraph - Business - - Front Page - Am­brose Evans-Pritchard

Risks of a dou­ble-dip re­ces­sion in Amer­ica are re­ced­ing. Not even Covid-19 can re­press the dy­namism of US cap­i­tal­ism for long. The euro­zone is another mat­ter. The IHS Markit com­pos­ite sur­vey for Septem­ber has fallen back to the boom-bust line at just 50.1. Ser­vices are in con­trac­tion again – even in Ger­many.

The equiv­a­lent US in­dex is in rude good health, with busi­ness or­ders ris­ing at the fastest pace in two years.

Europe’s re­cov­ery was al­ready fad­ing be­fore the sec­ond wave of Covid-19 struck, a trun­cated V preg­nant with eco­nomic, so­cial, and po­lit­i­cal trauma to come.

It is why the EU can­not risk the un­forced er­ror of a no-deal Brexit, dou­bly so given that Lon­don is ask­ing only for a bare-bones Canada tie-up. Brus­sels will have to dial down its ex­trater­ri­to­rial de­mands to pro­tect its £95bn trade sur­plus.

We are start­ing to dis­cern a re­play of the transat­lantic de­cou­pling seen af­ter the global fi­nan­cial cri­sis. The US kept pump­ing in stim­u­lus un­til the econ­omy had reached es­cape ve­loc­ity. The euro­zone thought it had done enough – in­deed, it tight­ened hard – com­mit­ting a series of mis­takes that ended in the Lost Decade. The con­tours are dif­fer­ent this time. The di­ver­gence is not.

The US is still in trou­ble, but re­tail spend­ing has held up bet­ter than feared since a di­vided Congress al­lowed the $600 weekly aid pack­age for 30 mil­lion peo­ple to ex­pire (tem­po­rar­ily) in July. House­holds are still draw­ing down on $1.6tril­lion of ex­cess sav­ings ac­cu­mu­lated over the lock­down. Homes sales hit a 14-year high in Au­gust.

For all the blus­ter on Capitol Hill, Congress is edg­ing to­wards a bi­par­ti­san deal worth $1.5tril­lion, with $500bn for state and lo­cal gov­ern­ments, and a $450 weekly check for those un­able to work. Don­ald Trump says he can live with it. Who­ever is elected, more is in the pipe­line later.

“We’re un­abashed op­ti­mists,” said An­drew Hol­len­horst from Cit­i­group. The Fed­eral Re­serve has more or less pledged to avoid any re­peat of past “taper tantrums”, keep­ing in­ter­est rates pinned to the floor and run­ning the econ­omy hot un­til 2023, even if in­fla­tion blows through 2pc.

It is im­pos­si­ble to be more dovish. The Fed is sig­nalling that it will re­sort to the ul­ti­mate weapon of yield con­trol if need be. It still has am­mu­ni­tion.

The euro­zone is on another eco­nomic planet. The Bank of Spain has just down­graded its GDP fore­cast again, ex­pect­ing a con­trac­tion of up to 12.6pc this year, with full re­cov­ery pushed out un­til 2023.

France has lifted its fore­cast slightly to mi­nus 10pc this year (from mi­nus 11pc) but may have jumped the gun. Em­manuel Macron is de­ter­mined to avoid a sec­ond lock­down, but the 14-day toll of new cases has rock­eted to 198 per 100,000 and is now worse than the first wave in March.

The French Con­seil Sci­en­tifique has al­ready laid out the cri­te­ria for ex­treme coun­ter­mea­sures. Should it de­clare that the pan­demic has again reached a “crit­i­cal state”, Mr Macron can­not ig­nore the ad­vice ex­cept at great po­lit­i­cal risk.

EU lead­ers do not have any eco­nomic mar­gin to play with. The Stoxx 600 in­dex of Euro­pean banks this week fell be­low lev­els seen dur­ing the panic sell-off in March, or even dur­ing the euro­zone bank­ing cri­sis.

It has been a slow death spi­ral, made worse by neg­a­tive rates that erode their bread and but­ter lend­ing mod­els. Bos­ton Con­sult­ing says the net in­ter­est mar­gin of banks has been whit­tled down from 250 ba­sis points to al­most zero. Len­ders will soon face the ham­mer blow of mass in­sol­ven­cies from Covid-19 as gov­ern­ment loan guar­an­tees ex­pire.

Con­sul­tants Oliver Wy­man es­ti­mate that bank losses could reach €830bn over three years, with half of the Euro­pean lend­ing sys­tem barely sur­viv­ing, un­able to gen­er­ate enough from re­tained earn­ings to re­build their de­fences. They are al­ready act­ing pre-emp­tively to shore up their cap­i­tal buf­fers, tight­en­ing credit lines to vul­ner­a­ble firms.

Euro­pean lead­ers hailed their €750bn Re­cov­ery Fund as a Hamil­to­nian mo­ment that fi­nally en­dowed the EU with its own fis­cal fire­power. In real­ity the EU did just enough to mud­dle through the im­me­di­ate cri­sis.

“Rather than a ‘game changer’, we see it as another ex­am­ple of the same ‘game’ that has pre­vailed for the past decade. When­ever the co­he­sion of Europe faces clear and present danger, Euro­pean gov­ern­ments agree to the min­i­mum demon­stra­tion of unity to keep the risk of break-up at bay,” said Ar­naud Marès, Cit­i­group’s chief Europe econ­o­mist.

What they cre­ated was a Brus­sels slush fund. The money does not kick in un­til mid-2021 and is then spread thinly across the EU over five years. The ad­di­tive im­pact is triv­ial.

As al­ways, the ECB is left to pick up the pieces. Chris­tine La­garde has be­gun talk­ing up a fur­ther €500bn of pan­demic QE next year but such ritual in­can­ta­tions no longer have po­tency. The yield curve is al­ready flat. Long bonds are on neg­a­tive yields out to ten years’ ma­tu­rity. The main pol­icy rate is mi­nus 0.5pc and at – or be­yond – the “reversal rate” where cuts be­come coun­ter­pro­duc­tive.

Ja­pan­i­fi­ca­tion is set­ting in. Core in­fla­tion has dropped to an all-time low of 0.4pc. There is al­most nothing that the ECB can do to com­bat this de­fla­tion­ary freeze or to re­vive eco­nomic growth, short of be­com­ing a mon­e­tary-fis­cal Re­ichs­bank and fi­nanc­ing deficits di­rectly. Such ac­tion would court po­lit­i­cal fate when the Ger­man Con­sti­tu­tional Court is al­ready on the warpath.

There is no im­me­di­ate pres­sure on EU debt mar­kets. ECB bond pur­chases hide all sins. Risk spreads are beau­ti­fully behaved. But this is not a sta­ble equi­lib­rium. Sov­er­eign debt ra­tios will reach ex­treme lev­els across much of the Club Med bloc this year, hit­ting 160pc of GDP in Italy.

What­ever they claim, EU lead­ers never com­pleted the euro­zone bank­ing union. The sov­er­eign-bank “doom loop” of 2012 is still there. All that has changed is the scale.

It is said that Bri­tish Brex­i­teers do not un­der­stand EU pol­i­tics and are de­lud­ing them­selves if they think that An­gela Merkel and fel­low lead­ers will com­pro­mise at the eleventh hour to avoid a trade shock. One might turn the ac­cu­sa­tion around.

The Euro­pean Au­to­mo­bile Man­u­fac­tur­ers As­so­ci­a­tion last week is­sued a full-throated warn­ing of a “€110bn Brexit dis­as­ter” for the in­dus­try if there is no deal. It said auto trad­ing on WTO terms would have a “cat­a­strophic im­pact” com­ing on top of Covid’s wave one, let alone wave two.

The prob­lem for Bri­tain is no longer whether or not there will be a trade deal. Of course there will be a deal. The prob­lem is that Europe’s econ­omy is in­ca­pable of gen­er­at­ing self-sus­tain­ing growth and is in fun­da­men­tal cri­sis. And whether we like it or not, we are part of it.

New York’s Chrysler Build­ing. The US is still in trou­ble, but has kept pump­ing in stim­u­lus un­til the econ­omy has reached es­cape ve­loc­ity

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