Disillusionment In Europe

There are a few stories I’ve been following in Europe which I will discuss in this article. I will discuss the recent European CPI report, the problems facing UniCredit, and the political risk in France. All the issues in Europe are related. The seams of the social contract in Europe are fraying. What I mean by this is the people don’t trust the government. This leads to a volatile situation where a politician who moves the Overton Window can gain power. The Overton Window is the range of what ideas are acceptable in public discourse. The people aren’t acting irrationally; it’s the government which has gone awry. The European Central Bank is buying corporate bonds, the Italian banks are losing unfathomable amounts of money, many of the countries in Europe have debt to GDP ratios above 100%, immigration has gotten out of control, and the underground economies are allowed to flourish.

Monetary policy isn’t generally part of the public discussion, but if it was I’d consider buying corporate debt to be far outside the Overtone Window 10 years ago. It can only end in disaster. There’s no way to unwind it. It creates inefficiencies in the system when firms can borrow at below the market rate. The most prominent problem is firms aren’t inhibited from taking high risk because they will always have the government to backstop them. It’s the definition of a morale hazard. The policies in action today are like the which caused the 2008 financial crisis except on steroids.

In a previous article, I mentioned the CPI in Germany rose to 1.9% which is near the 2.0% limit for all of Europe. The 2% inflation rate is a hard ceiling, which would necessitate ending the $60 billion per month QE program and possibly cause rate hikes. I mentioned that it could spur political risk if it came in below expectations because Germany would be feeling the pinch from high inflation without any policy responses from the ECB coming to the rescue because it can’t only focus on one member state. However, this didn’t happen as the inflation rate was 1.8% which was above the 1.6% expectation. This was the highest level since February 2013. However, policymakers are pointing to the 0.9% core inflation rate as the reason to not turn hawkish.