Economist A. Gary Shilling: ECB Could Use Private Banks for Euro Zone QE

Joel Anderson |

gary shilling, A. gary shilling, ECB, Mario Draghi, negative interest rates, QE, quantitative easing, deflation, inflation

Economist A. Gary Shilling has been accurately predicting major economic trends for decades, notably calling the end of double-digit inflation in the 1980s. Today, he’s the President of A. Gary Shilling & Co. and produces a monthly newsletter, Insight, which gives its readers specific, exhaustive insight into the key economic indicators investors need to understand and what those trends could mean to their portfolio.

With the European Central Bank (ECB) and Mario Draghi finally taking action to counter what appeared to be the collision course with deflation the Euro was on, talked with Gary Shilling about the future of the Euro zone and where the Chinese economy may impact Western markets.

EQ: The last time we spoke, you mentioned that one of the possible moves Draghi might make is negative deposit rates, which he obviously did earlier this month, as well as cutting interest rates and offering cheap rates on long-term loans. But he said he wasn’t done, though. What do you think the next move is from Draghi and the ECB?

Gary Shilling: It’s probably some form of quantitative easing. Now, the European Central Bank has already done that. As a matter of fact, we talked about that at length in our May newsletter Insight. The ECB has not actually gone out and bought treasury securities as the Fed has done in the United States. But it has done so indirectly.

At the end of 2011 and beginning in 2012, the ECB basically lent €1 trillion to its 800 member banks. And what did those banks do with it? They brought the sovereign debt of their respective countries. The Spanish banks bought Spanish government debt, the Italian banks bought Italian government debt, etc. Nobody else would buy it at the time because those governments were selling as junk securities.

And so the ECB was, in effect, buying the sovereign debt of these respective countries through these private banks. So they’ve already done quantitative easing but done it through the banks. And, I think that’s something that they’d do again. As a matter of fact, they have said that between September and December of this year, they’re going to make 400 billion euros available to their member banks, as if they lend it out to the private sector. So, they’re really repeating that whole exercise.

EQ: So, the methodology for them is to just use private banks as the buyers as opposed to directly putting them onto the ECB balance sheet?

Gary Shilling: Yeah, that’s right. Because there are 18 countries within the euro zone and to go out and buy the government bonds of each and every one of those proportionately would be pretty messy. Some of those markets are small and they don’t trade that often, so this is a much easier way of doing it.

EQ: And was the last round effective in getting these banks to invest in the government securities?

Gary Shilling: Well, it was. As a matter of fact, those banks have subsequently repaid much of those loans.

In July of 2012, Draghi came out with his now famous statement that he would do “whatever it takes” to preserve the euro. And, he then added to that “and believe me, it will be enough.” And, that did enough to quell the markets. It was the open mouth policy, and it worked. Although, it was in addition to that massive quantitative easing I mentioned earlier.

Now, I don’t think talk alone will do it this time. I think they’ll have to do more. You and I talked in our last interview about the measures that they were likely to take and did take on June 5th. They were pretty limited. They’ve reduced the lending rates from 25 basis points to 15 and put a penalty rate of 10 basis points for money left by the banks at the ECB. That’s pretty small potatoes. It’s more symbolic, and I think now they’re going to have to follow this up. Because they do want a weaker euro. It has weakened a bit, but it hasn’t fallen tremendously against the U.S. dollar.

EQ: But given that we’re just under three years out from the last time they tried to promote asset purchases this way and they’re staring down the barrel of deflation again, do you think they’re just going to try the same thing but in much greater quantities? Or are they going to change it up?

Gary Shilling: They very well could. If you look at what happened in this country, Japan, and the UK as a precedent, they started out small and they kept upping the ante to get results. Of course, in Europe they’re pushing against tremendous deflationary forces, tremendous consolidation forces among financial institutions, and the banks are more important there in financing business. 70% of lending in the Eurozone is through the banks with very little in the bond markets; it’s almost the reverse of the United States. And the banks are not in very good financial conditions, so the ECB has an uphill battle to start with.

I think it means that they will push harder and get enough money out there that it does depreciate the euro. Because their primary goal here is to air out deflation and they see that spearheaded by this strong euro, which makes imports cheaper in euro terms. And then, any domestic competitors who compete with those imports have to reduce their prices.  This is what the ECB is concerned about: deflation. So, they figure if they can trash the euro, they’re going to curb the deflation threat.

EQ: CPI inflation has finally hit 2% here in the United States. Do you have a strong opinion as to whether that’s a result more so of the effects of QE, or do you think the acceleration of the economy should get more credit?

Gary Shilling: I’d say it’s more of random event so far. Actually, the Feds’ favorite measure, which is called the core Personal Consumption Expenditures Deflator, the latest reading on that was 1.5% year-over-year. I think that as far as the Fed was concerned and as far as I’m concerned, you’d have to see probably four to six months of higher inflation rates to be convincing. A couple of months don’t tell you much, either on the upside or the downside.

EQ: You wrote a four-part piece for Bloomberg illustrating a number of issues with the Chinese economy arguing that it might be facing a period of significantly lower growth than a lot of people have been hoping for. What do you think that means to both Europe and the United States beyond the obvious slowdown?

Gary Shilling: Well, China is the second largest economy in the world now, but on a per-capita basis, its GDP is a fraction the size of the U.S.  Also, China is a net exporter. So China isn’t taking a lot more of exports from Europe and the U.S. than it is sending to those areas.  A slowdown in China is not quite the same as a slowdown in a country that was a big importer of U.S. exports and European exports, which would tend to slow those economies. So, I think the effects on Europe and North America are limited. The greater effects are on commodity producers that export iron ore, copper, coal, etc. to China. Australia’s big in that area, for example, and so are Brazil and Indonesia.  Those are the countries that I think are the most at risk from a slowdown in China, and they already have been affected.

EQ: Yeah, absolutely. But, do you think that if China slows down significantly that might ultimately benefit manufacturing here in America?

Gary Shilling: It already has. Commodity prices have been declining since the beginning of 2011, and that reflects a lot of excess capacity that was built up back in the big commodity bubble days in the middle of the last decade, and also, the weak economies globally. And, that’s already taking the heat off of a number of U.S. manufacturers, wholesalers, and retailers. You see a company like Kroger, for example, a very well-run retailer, but it simply could not pass on higher commodity prices to consumers. Proctor & Gamble prides itself on selling premium products at premium prices. It couldn’t do it earlier so P&G had to move more to house brands and that wasn’t their natural strength. So weaker commodity prices have taken a lot of heat off of U.S. companies that cannot pass on price increases. Consumers are just not willing to accept them. They don’t have the incomes to pay for it. So, if these U.S. companies get some further relief on commodity prices, it helps them considerably.


Gary Shilling is the President and Founder of advisory and consulting firm A. Gary Shilling & Co.You can reach them toll free at 888-346-7444.

Gary Shilling's monthly INSIGHT newsletteris a comprehensive 30-to 40-page report that includes extensive overviews of the economy...exhaustive investigations of key economic indicators and how they affect your investment portfolio...detailed examinations of emerging business and financial trends that could spell opportunity or danger to you and your investments...his investment themes...a wrap-up of key economic data...and Gary Shilling's back-page Commentary on matters great and small.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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