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