- I’ll describe what communism is and how close Europe is to it.
- I’ll analyze the implications the current monetary environment will have on investments in Europe and the European currency.
- You can’t compete with a European company that borrows at negative interest rates.
Now, the title of today’s article is a pretty heavy statement, but let’s look at the definition of communism and what’s currently going on in Europe to see how far Europe is from actually being communist.
One of the definitions of communism is as follows:
“A theory or system of social organization based on the holding of all property in common, actual ownership being ascribed to the community as a whole or to the state.”
So if the state owns producing assets or has a strong impact on the market, not allowing for natural supply and demand forces to occur, then we could say that the political system is more skewed toward communism than it is toward capitalism.
Let’s take a look at what’s going on in Europe.
ECB Involvement & The Asset Purchase Program
As we all know, Central Banks have been really active on financial markets in the last 8 years. Their goal has been to provide the necessary liquidity to avoid recessions or even depressions.
Now, all the FED has done is to buy Treasuries, but the European Central Bank (ECB) and the Bank of Japan (BOJ) have gone a few steps further. I’m going to focus on what the ECB has done in today’s article for practical reasons.
The following figure best describes what’s going on in Europe. Under the excuse that inflation must be around 2% per year, the ECB implemented its asset purchase program in 2015.
Figure 1: ECB asset purchase program consists of public and corporate bonds, and asset backed securities. Source: ECB.
So the ECB is buying €80 billion worth of assets on the open market per month. €80 billion per month adds up to €960 billion per year, or almost 10% of the Euro-area GDP.
Now, if a Central Bank buys assets in the amount of 10% of the countries’ GDP, I wouldn’t call that a free market as it’s a situation that is far away from the spirit of capitalism.
Most asset purchases have been towards government assets, but still, a significant part have gone to corporate purchases.
Figure 2: Distribution of the ECB asset purchase program. Source: ECB.
Let’s first look at how the political system is under the influence of the ECB, and then at how the corporate system is. Both are closer to communism than to democracy and capitalism.
The best description of how the political situation in Europe is rigged comes from the ECB’s buying activity prior to the French election in April 2017.
In March 2017, the ECB was focused on buying French bonds to keep the situation as stable as possible in France and influence the outcome of the presidential elections.
Figure 3: ECB went heavy on French bonds in March. Source: Citi.
So it’s clear that there is a relationship between monetary policy and politics, thus not exactly democratic. The impact on the corporate situation is even worse.
Before 2015, investors didn’t like Europe primarily because the demographic indicators weren’t—and still aren’t—that good, and emerging markets and the U.S. offered much better investment opportunities, and thus this resulted in capital outflows.
In order to improve the situation in Europe, the ECB stepped up and increased monetary stimulus through asset purchases.
Figure 4: The ECB inverted the capital flows in Europe by directly injecting money into the system. Source: ECB.
So, it shouldn’t be a surprise that an actual pickup in economic activity in the EU didn’t happen until 2015.
Figure 5: EU GDP growth per year in the last 5 years. Source: Trading Economics.
Why did the situation suddenly improve in Europe? Well, if you’re a corporation and you can borrow at negative interest rates, you suddenly become much more competitive on a global level. And this is exactly what the ECB has created, a corporate environment where corporations can borrow at negative interest rates.
In total, the ECB has bought €96 billion of corporate bonds which is a huge amount in a €1.5 trillion market. This has distorted the market, and 15% of the euro corporate bond market has negative yields.
So if you have recently bought a BMW or a Mercedes, know that it’s subsidized by the ECB which buys bonds and consequently distorts the natural process of financial markets.
Figure 6: Corporate bonds bought by the ECB distort interest rates. Source: Bank of America.
This ECB activity doesn’t allow for bankruptcies and keeps many companies that aren’t efficiently managed alive which is similar to what the case was in communist Europe with state-owned companies.
Just as an example of the distortion in Europe, Deutsche Bank recently priced a €350 million, 5-year bond to yield -0.006%. Try to compete with that.
What’s With The Current Spike Of The Euro
Nothing has actually changed with the fundamentals, the ECB continues with its buying activity and thus the spike is just a result of speculation. All that has changed is that the ECB has told the world it will contemplate a way to lower financial accommodation without roiling the markets.
This is practically impossible because the European system isn’t strong by itself and the only thing keeping it alive is financial accommodation. This can’t go on forever and therefore it’s extremely risky to be long anything related to the Euro because it’s a currency on very shaky legs.
It all might look good at the moment, but at the first sign of a shock, all of the above will probably backfire. A look at the global banks’ stress ratios shows that many European banks are severely to extremely vulnerable to shocks.
Figure 7: Moody’s global bank stress test levels (Europe is mostly orange). Source: Moody’s.
Now, I know that I might sound like a fool by writing what’s in this article, especially since everything is finally going well with the European economy which is also logical as someone is buying 10% of the European GDP. Nevertheless, my first hope is to raise awareness.
I know I can’t go against the buying power of the ECB, but pointing out the structural fallacies of such behavior is extremely important. I don’t know when things will change in Europe, but this article clearly identifies the risks of the ECB’s behavior and as such, international investors should avoid Europe.
From an investment perspective, the above shows how the recent appreciation of the Euro is purely speculative, how the fundamentals are terrible, and how European risks are getting bigger and bigger with every ECB purchase. As we all know, a system that isn’t based on healthy fundamentals will crack sooner or later and lead to devastating consequences.
We don’t know when things will crack, but for me, it’s enough to know that it will crack in order to avoid investing in investments that are dependent on the ECB’s buying activities.
As for communism, it’s clear that market forces can’t be applied to European businesses and political outcomes. Thus, perhaps it isn’t communism at its purest, but it definitely isn’t a democracy nor a fair market.