The scandal at Volkswagen AG over the diesel which began on September 18th, 2015, when the United States Environmental Protection Agency (EPA) issued a notice of violation of the Clean Air Act to German automaker Volkswagen Group. The agency had found that Volkswagen had intentionally programmed turbocharged direct injection diesel engines to activate some emissions controls only during laboratory emissions testing. The programming caused the vehicles to meet US standards during regulatory testing, However, they were actually emitting up to 40 times more pollution than they proclaimed.  Volkswagen included this programming scheme in about eleven million cars worldwide, and 500,000 were in the United States during model years 2009 through 2015.

Volkswagen Group sells passenger cars under the Audi, Bentley, Bugatti, Lamborghini, Porsche, SEAT, Škoda and Volkswagen marques; motorcycles under the Ducati brand; and commercial vehicles under the marques MAN, Scania, and Volkswagen Commercial Vehicles. It is divided into two primary divisions, the Automotive Division and the Financial Services Division, and has approximately 340 subsidiary companies. VW also has two major joint-ventures in China (FAW-Volkswagen and SAIC Volkswagen). The company has operations in approximately 150 countries and operates 100 production facilities across 27 countries.

Volkswagen Group agreed to plead guilty to a major conspiracy to defraud the U.S. government and obstructing a federal investigation into its violation of emissions standards. The U.S. prosecutors also charged six individual German VW executives for their alleged roles in the scheme. The company agreed to pay a $2.8 billion criminal fine and $1.5 billion in civil penalties for rigging more than half a million vehicles with software to cheat pollution laws and lying to U.S. investigators about the nature of the conspiracy. In January 2017, the FBI arrested Oliver Schmidt, a German who is the former top emissions compliance manager for Volkswagen in the United States while on vacation in Florida on a charge of conspiracy to defraud the United States. Many top German businessmen from the auto industry cannot travel to the USA or through the USA even on a stop-over for fear of being arrested.

German prosecutors have also widened a criminal investigation into Volkswagen’s Audi unit after authorities accused the luxury car maker of installing a system designed to evade emissions rules in cars in Europe, a major shift for an inquiry that has previously concentrated on the United States. Volkswagen Chief Executive Martin Winterkorn resigned back in 2015 over the scandal. The criminal investigation is now looking at the entire German auto industry much closer.

This is the serious issue that could undermine the entire German economy if it continues to spread throughout the industry. Beware, that the rally in the Euro is clearly a reactionary one and is by no means sustainable long-term. This could be the very issue the expands in 2018, so keep this in the back of your mindset. There are other bombshells yet to fall. While Audi must recall 24,000 vehicles it sold with the pollution software manipulation, there are studies said to exist in the US which the lawyers may unleash claiming that there is a clear correlation between a increase of lung cancer connected to the introduction of diesel trucks, buses, and cars. Even in Britain, the government encouraged people to buy diesel for the environment. It was the German auto industry who asked government to come up with tax cuts on diesel to further support sales. Politicians are turning against the German auto industry in a very major way for their careers always depend on getting the bad guy. If a barrage of lawsuits come flying out over pollution as was the case with asbestos, the future of Europe may appear much darker than many suspect.

Our European Tour this season has been very enlightening including meetings with politicians, corporations and many of the top banks. The concern centers around the ECB having to change policy with regard to negative interest rates. The net result has been to create massive hoarding of cash rather than spending cash for the sake of just spending. The banks were hopeful that a rise in rates will bring the money pouring back in for deposits. The real concern has been that the authorities are hard on the big banks while ignoring the small banks. This is true even in Germany, for the lending on real estate in Europe has been extensive and the credit has been questionable although the lending limit on property is running about 80%. However, the income requirement is not stringent and if rates begin to rise, the fear is there may be set in motion a real estate crisis in Europe similar to the S&L Crisis in the States.

Clearly, the big concerns have been that all the economic theories are turning to dust. Nearly 10 years of quantitative easing has utterly failed to reverse course and the banks are most vulnerable in Southern Europe namely in Greece, Italy, and Spain. The understanding of inflation has collapsed as has the quantity of money theory and the notion that when interest rates rose, the stock market should have dropped. All of these theories still taught in school have crumbled to dust in the real world and people are more and more reaching out for help and explanations other than opinion. Where’s the research? They say.

The funds management industry is also in turmoil with the new regulations coming in shortly and the costs rising tremendously. Funds cannot afford to be in cash because of the negative yield so they have been forced into the share markets but not for the reason of outright bullishness. They simply cannot stand on the sidelines for now being in cash costs money in Europe. Many have turned to the dollar simply because there has been no alternative.

Pulling back the curtain reveals very increasing movements in capital. While the Euro rallies against the dollar, the yields in the German are rising while the Treasuries have been declining. This has shown that big money is looking at the Euro rally with tremendous skepticism and are still shifting to US Treasuries as domestic share prices also fall.

If the ECB finally begins to raise rates, then some money will flow back to Europe and into the banks. But this will be a short-lived trend. The underlying conditions are not stable and the core industry that supports Germany is the car industry. This witch-hunt going after diesel has the potential of seriously harming the Germany economy. If the attack on the auto industry continues, this will seriously impact the European economy as a whole.

Americans tend to ignore this because diesel cars are rare in the States. In Britain, about 50% of new car sales have been diesel and government encouraged people to buy diesel because they believed the fake research that diesel was cleaner than gasoline. The whole diesel scandal is very big in Europe and this has the risk of undermining the core of the German economy. The rumor is that Audi is having trouble. Audi must recall 24,000 cars due to a new instance of software manipulation resulting in excess pollution.

QUESTION: Mr. Armstrong; Thank you for coming to Frankfurt. Nobody gets that big of an audience here ever. What you illustrate with the three faces of inflation means that the Philips Curve no longer functions. Was this something like Kondratieff’s Wave that it was based upon a period that is outdated?

Thank you once again. I hope you do more of these type events.

BC

ANSWER: Yes. The Phillips curve is a graph describing the relationship between wage changes and price level changes on the one hand and the unemployment rate on the other.  The basic assumption was a fixed exchange rate so there was no issue of currency inflation. The Phillips curve was published in 1958 by the English statistician and economist Alban William Housego Phillips in the magazine Economica. It has been modified several times since. Paul A. Samuelson and Robert Merton Solow in 1960 expanded the Phillips curve. They created a link between unemployment and the change in the inflation rate but this was again under Bretton Woods and a fixed exchange rate system. The Phillips curve  assumptions are simply irrelevant today and yet central banks have continued to try to manipulate society based upon these antiquated theories. Every assumption they make to manage the economy is dead wrong right down to the Quantity of Money Theory