An alternative to caring about Draghi

Hard as it is to believe, it's already time for another ECB meeting.   A lot of water has clearly passed over the bridge since the last one, and while the DAX is largely unchanged since that October 2 "rien fait" result, the IBEX is some 5% lower and BTPs are off by a point.   More pleasantly, EUR/USD is actually a couple of big figures lower, largely as a function of USD strength engendered by the BOJ.  (That, signor, is how you weaken your currency!)

Given the ongoing doldrums of the Eurozone, the seemingly daily collapse in oil, and the rather tepid take-up of the first TLRTO, there's a school of thought that Draghi and co. will loosen some of the requirements to participate.  That, combined with the successful announcement of the bank stress test results, would putatively increase the incentive for banks to apply for loads more liquidity.

Or will it?

Unlike during the time of the original 3 year LTROs, there aren't exactly a lot of high-carry trades on offer, particularly at the short end of the periphery.  While the spread between the refi and the deposit rate represents the actual cost of holding excess cash, and remains as low as it has ever been, one would have to presume that the act of "cutting a check" to the ECB for the privilege of parking cash there is one that many banks will wish to avoid.

More generally, of course, one can clearly question whether there's anything else the ECB can reasonably (and practically) do.   Yes, theoretically they could engage in a swashbuckling BOJ-style orgy of monetary munificence....but there is no other central bank in the world where the chasm between theory and practice is so wide.

Moreover, while there is clearly a demand-related deflationary impulse in Europe, the genesis is a fiscal one, and there is little empirical evidence that any amount of monetary pump-priming can replace the salutary effects of time in resolving the problem.

At the same time, the trend of disinflation/deflation is a global one, caused in many cases by global factors.  A by-no-means-exhaustive list includes the following:

* Globalization has shifted the supply curve for many, many goods (and some services) much more abruptly than the demand curve; the equilibrium level of many prices has therefore shifted lower.  Observe the PCE deflator for durable goods; although it also declined (by more, in percentage terms) during the Great Depression, the current 20-year secular decline reflects a structural supply shift rather than a shock-induced demand shift.

* Technology such as the Internet has had a profound impact upon the world economy in terms of efficiency of communications.  Productivity in many aspects of economic life has shot higher as well (insert Facebook joke here.)

* The payoff of fixed investments is still being reaped or, in the case of the commodity sector, just starting to be reaped.  Although the TMT infrastructure bubble didn't necessarily work out so well for many of the firms that did the work, it is a sunk cost the benefits of which are still being enjoyed today.  Commodities, meanwhile, move in super-cycles given the extraordinary intensity of the capital expenditure required to bring new supply on-line.  A glance of the last decade of the Australian dollar illustrates where we've been in that cycle; a brief trawl through some of the comments made by some of the usual-suspect resource firms should leave you under no illusions about where we're headed.  At the same time, the world's largest fossil-fuel consumer has become less dependent upon global production.

None of these factors are particularly unique, but then again neither are periods of secular price declines or stagnation.  Consider that the first transatlantic telegraph cable was laid in 1858.  Eleven years later, the first transcontinental railroad across the United States was completed.  These innovations, combined with the end of the Civil War, enabled the US to fulfill the 19th century role occupied by China today.  US exports as a percentage of the global total exploded from 7.9% in 1870 to 13.2% in just 10 years.  And what did inflation do during this period and its aftermath?

It was negative for much of the time.

Source: www.irrationalexuberance.com

So what does this mean for inflation targeting?  A student of history might suggest that for central banks to target a completely arbitrary (positive) inflation figure against the tide of disinflationary/deflationary factors cited above (as well as others) is akin to King Cnut ordering back the waves or Xerxes the Great shackling the sea for breaking his pontoon bridge across the Hellespont.

In other words, futile.

In fact, worse than futile if their efforts to combat forces that are clearly beyond them (does anyone think any easing Draghi might do will positively impact the price of oil?) lead to substantial price distortions in items and assets that are more easily influenced by central bank policies.

Indeed, one could argue that this is the narrative of the last 20 years of central banking in the United States.

Of course, the realpolitik is that in a world still awash in debt, deflation is a distinctly unsavoury outcome.  Small wonder, therefore, that in a world where schoolchildren get "participation awards" rather than winners' medals, monetary authorities are trying their damnedest to keep the balls in the air as long as possible to shield as many people as possible from unpleasantness.  For better or for worse, the exaggerated economic cycles of 140 years ago are simply unpalatable- even though those countries that "took their medicine"  during the crisis seem to be faring rather better than many of their peers these days.

None of this means that you should buy or sell euros or Spooz today or tomorrow.  Sometimes, however, it's worth taking a step back and considering where we are in the very big (dare we say macro?) picture.  It's certainly more interesting than wondering if and how the ECB might adjust their latest string-pushing exercise....