Friday, 23 January 2015

Euro QE decision underscores trouble ahead

The European Central Bank (ECB) announced this morning it would begin an expected programme of injecting money into the ailing economic union.

However, the expected timeline, sheer size and aggression of the bond buying programme has surprised many.

The markets had “priced in” a potential quantitative easing (QE) programme of between 500 and 600 billion euros, but ECB president Mario Draghi says the plan will involve buying 60 billion euros of debt per month until September 2016.

This brings the expected injection of new money closer to 1.1 trillion euros by the time the programme will end, almost doubling what the market planned to accommodate.

As a result, the markets have reacted appreciably with a weakening of the Euro dropping to $1.15 to the US dollar for the first time since 2003.

The New Zealand dollar also slipped to below US75c for the first time since 2011 after the news was announced.

Far from fixing the economy however, the decision to go ahead with the QE plan represents a worrying step in the direction of disintegration for the troubled European Union.

Essentially, this particular ECB decision - and the all-important details - was made to accommodate significant German pressure leveraged against the programme.

As the European Union’s largest economy, Germany has been concerned for a while that a bond-buying plan of this size would shoulder it with too much of the crippling sovereign debt accumulated by the weaker peripheral states of Italy, Spain and teetering Greece – among others.

The deal, carved out by Mr Draghi, pushed most of the responsibility of buying the bonds back on individual European national banks, rather than the ECB itself. He says the central bank will only purchase 8% of the bonds, while national banks will have to front the remaining 92%.

While this pleases the Germans, allowing them to continue exporting more than 50% of German-produced goods into the Eurozone (a requirement at the bedrock of Germany’s reasons to remain inside the EU), the deal opens whole new series of questions.

Rather than being about the economic status of the union, these more sinister questions are about the EU’s far more dangerous political and social crisis simmering under the surface.

From the inside, Mr Draghi’s decision to stimulate the EU economy is seen as necessary. Whether it will work, as New Zealand Initiative director Oliver Hartwich believes it will not, is another question.

But from the outside, the fact that the central bank in cooperation with the European Court of Justice can decide on and enact a programme that treats the European Union as a group of individual states, rather than as a coherent whole, will have long term repercussions.

Not all of those repercussions will be positive. The reason the EU was created in the first place was to avoid repeating the cataclysms of the 20th century. Europe’s problems during the last century were complex, but one historic thread suggests they were exacerbated by a refusal of the people on the peninsula to see themselves as truly “European”.

Instead, the various people-groups preferred the identities of arbitrary heritage over common geography. The rhetoric emanating from Europe since the crisis has gradually increased the preference to identify once again as “French” or “German” or “Greek”, rather than simply European.

Today’s ECB and the recent ECJ decisions to allow the system to treat the individual countries as in control of their own finances might be legal and follow the rules and technicalities to the letter. But the real message will undermine the fundamental ideology and reason for existence of the union.

If the sovereign debt can be farmed out to individual states, then the ability to make their own decisions regarding seemingly smaller problems cannot be ruled out in the future.

For instance, the issue of immigration in the EU is a huge political thorn. The treaty allowing full freedom of travel inside the union is often used responsibly by members, but it can be leveraged by asylum seekers.

Should the Romanian parliament decide that it doesn’t want immigrants coming into its country just to gain access to jobs in France, and opts out of the treaty, what would Hungary’s resultant decision likely be? Would they stay in, or opt out too?

And should it prove painless to change small rules such as this, how simple might it be for Greece or Italy to begin a process of blocking cheap German goods from being exported into those countries?

At some point, and with this morning’s decision reinforcing the viewpoint, the European Union moved from being a coherent idea to only a useful temporary solution with laws and treaties being increasingly subject to alteration.

The future may not be nearly as dire as all this, but it is worth keeping in mind how fragile the union truly is and that the pain – both economic and political – has not ended with an injected trillion euros.

Wednesday, 21 January 2015

Investors rush to low Spanish bonds as EU QE plan looms

Global investors predicting large-scale European Central Bank (ECB) bond buying this week rushed in to Spanish debt this morning in a surprising show of confidence.

Spain opened one of its largest ever bond sale at a record low rate Wednesday morning, attracting a reported €23 billion ($34 billion) from across the globe.

Last year, Spain paid close to 4% to borrow money for 10 years. This morning, according to the Financial Times, it paid only 1.66%.
Although Germany and France appear to be politically playing the expected quantitative easing (QE) programme down, peripheral states such as Spain and Greece most affected by the festering economic crisis stand to benefit from billions of new funds potentially entering the currency union.

After weeks of playing with the idea of organising some variation of QE in the Eurozone, investors are showing early fresh interest in parking money in the troubled European Union.

This new demand is already pushing yields down to historic lows and encouraging Spain and others to lock in the low rates.

It is unclear yet whether the international sentiment indicates a widespread feeling of renewed financial security in the EU. This would be a welcome reprieve from years of low growth and a stuttering economy struggling to build back from the pain of 2008.

Harbour Asset Management director Christian Hawkesby says the prospect of the ECB providing more stimulus underlines that New Zealand’s economy, by comparison, continues to be in good shape.

“The New Zealand dollar has remained elevated largely because, in the economic beauty contest, we continue to be one of the least-ugly cases.

“The key for New Zealand investors will be in watching the difference between what the ECB announces it will do, and what the details are. That’s the immediate focus,” he says.

But the longer term attention will be in assessing whether the quantitative easing (QE) plan will truly help turn around the EU economy.

He says the prospect of European QE at the end of 2014 held bond yields down globally causing investors to look elsewhere for a secure yield in a defensive, high dividend share market. New Zealand was a “very popular destination” for that type of investment flow.

“But to the extent that people believe the ECB could be successful with this QE programme and encourage much-needed growth, then the focus could switch to investors looking for more growth oriented opportunities.

“New Zealand isn’t traditionally a growth market. So as a result, investors could begin to look at Australia instead where growth opportunities are more likely, particularly if its non-mining sector starts to take shape,” Mr Hawkesby says.

Analysts remain sceptical that the proposed money injection will fix the long-term crisis.

ECB president Mario Draghi has publically defended the idea of QE. To achieve the EU’s medium-term inflation target of around 2%, the bank must “keep interest rates low and must work towards an expansionary monetary policy which accompanies growth”.

Tuesday, 20 January 2015

The clash of Islam with democracy and the future victor

Throughout the past decade the narrative that the West is staring down Islam as an existential threat has been almost unquestionably accepted by mainstream consciousness.

That threat from Islam looks nothing like Nazism or Communism or any of the ideological competitors to democracy attempted in living memory. The United States and its allies have spent more than US$6 trillion in fighting militant Islamism since 2001. That is a big deal.

The narrative says the West faces a resumption of Samuel Huntington’s concept of a “clash of civilisations”, more recently described by historian Niall Fergusson as “the West vs the Rest”. We are told it is a zero-sum game. But it is not clear this is so.
This is the only time those disgusting Paris shooters will be mentioned. Nevertheless, the terrorist attack offers a chance to ask why the Western world has chosen to narrate the threat as an existential battle, rather than as marginal or ideological.

First it is necessary to gauge the success of Islamic violence over this Long War. The al Qaeda movement wished to topple Arab autocratic regimes and destroy the United States. It has been unsuccessful in these endeavours and was itself destroyed.

The splintering of al Qaeda has only threatened local governments, none of which are Western in any form or measurement. The deadly mutation known as the Islamic State nominally controls scattered parts of Mesopotamia but it too is slipping into oblivion under heavy US military pressure.

These groups struck targets in Western countries, while the US-led response has been effective at mitigating those strikes. People continue to die on both sides.

It is a nasty and dirty war, but the real reason Western governments focus so intently on militant Islam is not often discussed in polite company. It is not just about Islam, it is about humans.

Some people believe exposing government actions is the best path to change. Edward Snowden in the United States and Nicky Hagar’s publishing of the Dirty Politics book both operated from this assumption.

Yet if the truth is so bad, why doesn’t it often change anything? More importantly, why does power in the West seem not to overly care when the truth leaks? Because the system is not frightened of the truth, it is only frightened of a more effective lie.

Today the central dynamic of the modern Western government is self-doubt. That problem has becoming more pronounced with the rise of instant communication and the return of mass cultural rituals which were supposedly isolated from politics.

Democracy’s goal is to convince people that it is a workable process that can replace much older systems such as monarchies, strongmen or religion. It has been mostly successful but convincing people of democracy’s legitimacy seems to require far greater effort compared to the older options.

The democratic process works well when the structures of power are set up to reinforce it. For instance, it is successful when information can be centrally controlled and the public is well-educated. Neither of these are true anymore.

As a result the structure of Western democracy feels under threat. But it is threatened in a very particular way by Islam. The true threat to democracy is old religion of which jihadists represent the tip of the spear. Religion will always take less effort to convince humans than democracy can.

So since 2001, the form of the question presented to us has been for citizens of Western nations to place their trust either in secular democracy or religion. That is the only choice.

But to accept this form of the question misses why Western governments choose to think like this. The hidden goal is not a choice between two government systems. It is to convince citizens that the default stance is towards central government of some kind, not away from it.

The message is: Choose Pepsi or choose Coke, just stay in the system. Thinking in this way will only maintain the status quo and it won’t help fix the deep structural problems secular democracy is grappling with in this new century.

Religion “clicks” in human brains far more efficiently than secular democracy ever will. They have existed for far longer than democracy and if history is any guide, they will be victorious in the long run unless a better way is found.

This is why the narrative of painting Islam as an existential threat is at bottom a discussion over whether humanity will revert to old comfortable rituals or continue towards a more inclusive process of organisation.

It is becoming clear the answer probably is not to be found in a secular central democracy no matter how hard the concept is pushed. As always, the answer is probably somewhere in between. But it does need to exist. 

Monday, 19 January 2015

Saudis feel oil pinch as IEA predict long term gains

After dropping more than 50% in 2014, new data from Saudi Arabia’s biggest company suggests low oil prices are hurting the petro-state.

However, a recent report from the International Energy Agency (IEA) suggests that over the long term (out to 2040) the price of fossil fuels should trend back up. Although this will be little comfort for petroleum exporting countries this year.

Early this morning, Saudi Basic Industries Corp (SABIC) reported a 29% dive in fourth quarter net income, missing analysts’ forecasts by an enormous margin. Low oil prices are being blamed for the drop.

The Gulf’s largest listed company earned 4.36 billion riyals ($1.49 billion) in the three months to December 31, 2014. Compared with the year prior when SABIC earned 6.16 billion riyals ($2.11 billion) over the same period.

SABIC chief executive Mohammad al-Mady says the company’s outlook for 2015 depended on oil prices and is therefore unpredictable.

“This hiccup of lower crude oil prices is not the first time and will not be the last time - so this country will continue marching,” he says.

Agreeing with this long-term view, a recent report from the IEA says there will be an increase in demand for fossil fuels over the next few decades regardless of current trends.

The World Energy Report 2014 reports that world primary energy demand could be 37% higher by 2040, putting more pressure on the global energy system, before slowing “to a near halt” during the 2040s.

“The scenario shows that world demand for two out of the three fossil fuels – coal and oil – essentially reaches a plateau by 2040, although, for both fuels, this global outcome is a result of very different trends across countries,” it says.

World oil supply could rise to 104 million barrels per day in 2040, but will hinge critically on investments in the Middle East. As tight oil output in the United States levels off, and non-OPEC (Organisation of the Petroleum Exporting Countries) supply is predicted to fall back in the 2020s, the Middle East becomes the major source of supply growth.

IEA chief economist Fatih Birol says a well-supplied oil market in the short term should not disguise the challenges that lie ahead.

“The apparent breathing space provided by rising output in the Americas over the next decade provides little reassurance, given the long lead times of new upstream projects.

“The world is set to rely more heavily on a relatively small number of producing countries,” he says.

On the other hand, the world demand for natural gas could be more than 50% higher by 2040, and will be the only fossil fuel class growing at that time.

The United States remains the largest global gas producer, although production levels off in the late-2030s as shale gas output starts to recede.

“A key uncertainty for gas outside of North America is whether it can be made available at prices that are low enough to be attractive for consumers and yet high enough to incentivise large investments in supply,” the report says.

As for coal, its future use is constrained by measures to improve efficiency, tackle local pollution and reduce CO2 emissions.

Coal demand is 15% higher in 2040 with growth almost stopping in the 2020s. Regional trends vary, with demand reaching a peak in China, dropping by one-third in the United States, but continuing to grow in India.

By 2040, world energy supply will be divided into four almost equal parts: low-carbon sources (nuclear and renewables), oil, natural gas and coal.

And as the demand for fossil fuels plateaus, the IEA predict nuclear power will see an installed capacity grow to 60% with the increase concentrated heavily in just four countries – China, India, Korea and Russia.