Today’s title comes from the old Pete Seeger song of the same name. He originally wrote the song about an experience he had in the army when his platoon leader was leading them perilously through a swamp. The most famous line from the song was:
“We were waist deep in the Big Muddy and the big fool said to push on.”
Mr. Seeger, many thought, was using the song as an allegory to President Johnson and the war in Vietnam. The gist being, a fool marches himself into an impossible situation but convinces himself that the only way out is to keep going. Admitting a grievous mistake and backing out would be worse than pressing on and sinking further and further into the morass.
In fact, released phone recordings from President Johnson’s Library document the President speaking to his main patron and life-teacher, Georgia Senator, Richard Russell, as early as 1964. Senator Russell was probably the most respected member of Congress when it came to military policy. President Johnson asked Senator Russell what he thought about the growing conflict in Vietnam. Senator Russell said, “I never been right many times in my life, but I knew we were going to get into this sort of mess when we went in there, and I don’t see how we’re going to ever get out. It’s a hell of a situation; it’s a mess. And, it’s going to get worse, and I don’t know what to do.” President Johnson responds, “Well that’s the way I’ve been feeling for six months.” And yet, President Johnson pushed on and on anyway for the next four years.
The main lesson here is once leaders embark upon highly important and highly visible policies that end up going south, it’s extraordinarily difficult to admit mistakes and reverse course. They believe the public’s reaction to reversing course would be worse than continuing a failed and destructive policy.
I was thinking of this on Thursday when the Bank of England (BOE) came out with their first “Post-BREXIT” monetary stimulus package. Policy rates were cut; the Quantitative Easing policy was increased and broadened to include corporate bonds; and the BOE came out with new bank lending facilities to spread credit into the economy. My first reaction was that this move by the BOE gives the European Central Bank (ECB) the greenlight to increase their Negative Interest Rate Policy (NIRP) at the next meeting in early September. If you believe in my “Big Muddy” theory, the ECB is into NIRP way too deep to stop now. If the BOE sees significantly lower economic growth in the coming months due to BREXIT, that should have a relatively strong negative effect on Europe as well. With economic growth prospects for Europe worsening, the ECB will feel compelled to press on and decrease rates further as many senior ECB officials have said they would. At this point, reversing course is unthinkable and not going further would be seen as impotence. Being viewed as impotent is the central banker’s worst nightmare.
The European economy has to return to health if the global economy is going to return to an acceptable growth level. The key to Europe’s return to strong economic growth is fixing its banking system. The ECB’s NIRP runs counter to this needed outcome. Last Friday, the European Banking Association released the long awaited bank capital stress tests. The results were a passing grade for the system. However, by the following Tuesday, the benchmark Stoxx 600 Bank Index dropped more than 5%. Germany’s second largest bank, Commerzbank, came out with an earnings disaster and downgraded their profit targets for the rest of the year. The bank disappointed across nearly every business line. Reading comments from the bank’s earnings call sounded like a 45 year-old man going through a mid-life crisis. Other than cutting costs further, there really didn’t seem to be a plan to reverse the mess. And, with regard to cutting costs, once a European bank gets done firing all the Americans working for them, it’s a lot harder to fire workers from the home team.
Of all the complaints though, the main one that came from Commerzbank and just about every other bank in Europe, was the effect of NIRP. This policy has had, according to the bank, an adverse effect on every business from consumer finance to corporate banking. Commerzbank Chief Financial Officer, Stephan Engels said, “It is important to understand that there will be a continuous burden from the interest-rate environment.” I realize that there comes a point where blaming everything on the ECB becomes a convenient excuse for everything that is wrong, but NIRP is harming the European banking system, and increasing the policy will just make it worse.
Of course, there are other problems with the European banking sector that have never been addressed. While not as bad as the Japanese banks in the 1990s, the European banks have failed to address the tremendous amount of bad assets they have had on their books since 2008. This is a tremendous drag on their operations. Commerzbank reported that their unit for unwinding bad assets (they’ve been unwinding for eight years) nearly halved its operating loss from last year. Why does Commerzbank, Deutsche Bank, and just about every major bank in Europe still have significant “legacy assets?” In the United States, we got rid of ours and moved on. There’s money-management firms scouring the globe for any asset that has the potential for a positive yielding cash flow. There’s a clearing price for just about everything. Sell what you can sell, write off what nobody wants, and move on! Unfortunately, one of the worst hidden secrets in finance is, if the European banks did that, they might sink the whole system. So for now, the strategy is to die slowly and pray for a miracle?
So, what is there to do? The one completely obvious thing to me is, the ECB needs to end NIRP and stop depressing yields with their ever increasing Quantitative Easing policy. At least let the banks rebuild capital through earning a positive net interest margin so they can really begin to get rid of their bad assets. If Europe can’t fix its banking system, it can’t fix its economy, and that leaves the rest of the world looking to the USA to keep global economic growth above water. The United States job growth continues to be impressive, but we are really getting late in the growth cycle. The U.S. can’t do it alone for much longer. Unfortunately, a lot of our hopes rest with the ECB and I’m afraid “the big fool says push on.”
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