June 9, 2023: Global News Roundup
"It was not part of the plan. But we are dealing with it"—One-click bank runs, geopolitics, and energy prices worry central bankers as Europe slips into recession
The Global News Roundup collects news stories from entirely international (non-US) media sources on variety of pressing global issues and events.
A couple of weeks ago, Germany officially entered a recession, posting GDP declines for two consecutive quarters, fourth quarter 2022 (down 0.5%) and in first quarter of 2023 (down 0.3%). On Thursday morning, the whole of the European Union followed suit, with revised GDP data showing an 0.1% decline for each of the last two quarters. As the financial presses continue to debate whether this news warrants an interest rate hike, pause, or pivot from the European Central Bank when it meets next week (June 15), I decided to do a short review of speeches from various European central bank authorities to see what turned up.
Twelve speeches were delivered this week (between June 2 and June 8) by central bankers and monetary officials from across the eurozone and archived by the Bank of International Settlements. While there was plenty of talk of inflation and interest rates before the “quiet period” began on Thursday, the speeches also revealed extensive consideration of and concern about a variety of interrelated structural changes in how the global economy works. Among other themes worth exploring, European central bankers expressed concerns about:
1. The stability of the European banking system;
2. “Digital finance” and technological change;
3. Incoming sovereign and corporate debt defaults/crises;
4. Ukraine war, energy prices, and geopolitical risk;
5. Economic effects of the coronavirus pandemic;
6. Centrality of China to Europe’s economic health;
7. De-industrialization and problems in European manufacturing.
I discuss these issues below, roughly divided into subsections so you can skip around if you’d like.
Banking, technology, and digital finance
Christine Lagarde, President of the European Central Bank, mostly discussed interest rate policy and the general economic outlook for the eurozone, but also touched on geopolitics and the plight of European manufacturing. Lagarde placed blame for economic stagnation in Europe partly on Russia and energy price inflation associated with the war in Ukraine: “Business and consumer confidence indicators point to weak activity in the second quarter and remain lower than before Russia's unjustified war against Ukraine and its people.” She notes specifically that “the manufacturing sector is still working through a backlog of orders, but its prospects are worsening”, echoing concerns from other officials (below) about how high energy prices and shifting trade patterns are raising concerns about de-industrialization.
Like others who delivered remarks this week, Lagarde tried to calm investors and asserted the general stability of the European banking system, noting only “limited” exposure to the “recent banking sector stress”. Interestingly, and perhaps speaking to broad popular discontent with ECB policy, she concluded the talk by affirming that the role of the ECB is to “win the confidence of the citizens of Europe”, which she said remains “an important challenge”: “Together we must do all we can to keep listening and responding to concerns of European citizens.”
(Image: European Central Bank building, Frankfurt, Germany, picture-alliance/dpa, here).
Denis Beau, First Deputy Governor of the Bank of France, took on technological change and what it means for banking system stability, focusing largely on the “new digital finance ecosystem” and the related, recent failures of the FTX cryptocurrency exchange and tech-focused Silicon Valley Bank (SVB). Beau commented on the “one-click” banking system in which a “digitally-educated clientele” can almost instantly transfer funds, creating a “one-click bank run” that can be difficult for regulators to prevent and manage. Like Lagarde, Beau tried to sooth investors, arguing that while regulation in the US is inadequate to address this kind of one-click bank run, this is not the case for Europe where the ECB has more “intrusive supervisory powers” relative to its American counterparts: “Let me reassure you on one point: the European situation is radically different.”
Luis de Guindos, Vice-President of the ECB, echoed the sentiments of his colleagues about the banking sector: “The European banking sector has proven resilient.” (Some variation on the word “resilient” appears seven times in this speech, while Lagarde and Beau use it three times each). He also reiterated the significance of technological change for financial market stability and regulation, pointing to disruptions caused by digital banking and social media in the context of SVB’s collapse: “The extraordinary speed of deposit withdrawals was driven by the widespread use of online banking and the rapid dissemination of news via social media and was compounded by the highly concentrated customer base.” The speech concludes with de Guindos calling for a European “capital market union” (CMU) that would centralize regulation and supervision of debt markets, permit more effective “risk-sharing”, harmonize certain tax policies, and include a centralized deposit insurance scheme.
Likewise, Gabriel Makhlouf, Governor of the Central Bank of Ireland also reiterated the “resilience” of the European banking system (he used the term five times in his speech). Much as Beau (above) tried to separate problems with US banks from the “radically different” situation of European banks, for his part, Makhlouf separated Irish banks from “those banks that experienced difficulties in March” (seemingly referring to US-based SVB and Swiss-based Credit Suisse): “More stringent regulation, our macroprudential policy measures, and banks' own risk management practices are all contributing to a banking sector that is much better able to absorb adverse shocks than in the past.”
These comments about the banking system follow on the heels an ECB warning to major European banks late last month that they are vulnerable to deposit withdrawals especially by so-called “shadow banks”, i.e., funds and other non-bank lenders. The “systemically important banks” covered by the ECB’s warning include BNP Paribas, Deutsche Bank, BPCE, Credit Agricole, ING, Santander, Societe Generale, and UniCredit.
Debt, geopolitics, and the pandemic
Concerns about debt also loomed, especially for Klaas Knot, President of the Netherlands Bank, who warned about sovereign and corporate debt problems and “urged caution”. Calling for “bold, but realistic” policy, Knot further pointed to the role central bankers themselves played in generating financial system instability, the only discussions of this point I found in this week’s commentaries. Knot noted that, with relatively low inflation and low interest rates in the years preceding the pandemic, the ECB and other central banks deployed a series of “unconventional” tools, like large-scale asset purchases, which picked up pace when the pandemic hit, resulting in increased “vulnerabilities in the financial sector and real economy”. He finished up by discussing how while in theory the rising interest rates we see now are a benefit to financial institutions, in practice the rapid shift in policy will likely result in an “unruly” adjustment as borrowing costs rise and governments and corporations struggle to secure new financing: “[M]arkets can regard debts as sustainable for quite some period of time, before they no longer do. Such potential non-linearities call for additional caution.”
Boris Vuji, Governor of the Croatian National Bank, spoke this week about the economic policy lessons learned over the past four years, focusing on the importance of “resilience” to geopolitical shock, as well as “adaptability”, and “cooperation” (the sheer frequency with which some variation of the term “resilience” was used in this week’s speeches was uncanny; in Vuji’s case, 13 times). He noted that “We live in an increasingly shock-prone environment in which unpredictability is becoming the norm” and recommended “building resilience in areas most hit by the recent shocks – the energy sector and supply chains – while at the same time being mindful of the importance of fiscal prudence”.
Vuji also related an unexpected story about a medieval city-state called the Republic of Ragus, named Dubrovnik today and the same city in which he delivered the speech. Drawing an analogy to Croatia’s and Europe’s position over the past several years, Vuji notes that Ragusa’s government also had to manage frequent trade disruptions and disease outbreaks and did so while keeping government spending under control. He closes the comparison with the following pointed comment about foreign policy: “As for cooperation, despite hostile surroundings, Dubrovnik's military expenditures were minimal, as they instead were focusing on diplomatic efforts and negotiating skills.” Indeed, since the Ukraine war began in February 2022, Croatian President Zoran Milanovic and the Croatian government more generally have been somewhat critical of arms shipments and other supports the EU has offered to Ukrainian forces, though they have nonetheless lent modest financial support, creating “mixed signals” on its stance.
Geopolitics, energy, and industry
The Ukraine war was also a focal point for Dr. Joachim Nagel, President of the Deutsche Bundesbank, who shared concerns about its impact on energy prices and industrial growth. After the usual introductions and pleasantries, Nagel opened as follows: ““Is industry about to wither and die?” – that was the pointed headline used by the German journal “Der Spiegel” late last year to fire up the debate surrounding industry’s prospects for the German economy.” He went onto explain that, even before “Russia’s war of aggression against Ukraine began”, the German economy was already struggling from supply chain problems and inflation ignited by the pandemic. “Over the past two years, but especially as Russia’s war played out, energy costs then skyrocketed at times. And the years to come will probably see them persist at above pre-war levels here in Germany.” Nagel further added that demographic shifts (an aging population), efforts to reduce carbon emissions, and rising levels of trade protectionism around the world are making the problem for German industry even more challenging.
Importantly, Nagel also commented on the importance of China-Germany economic relations for Germany’s economic health:
One country has been key to the rapid growth seen in German foreign trade over the past two decades: China. That country has grown in importance for Germany, both as a supplier and as a sales market (see Chart 4). Trade between Germany and China has seen brisker growth since 2005 than trade within the EU (European Union) and with the United States. That holds true for both imports to Germany and exports from Germany. Overall, China ranked as Germany’s most important trading partner in 2022, for the seventh time in succession.
The slide below presents “Chart 4”, to which Nagel refers in his talk:
(Image: “China has steadily become more important to Germany as a foreign trade partner over recent years”, from PPT presentation accompanying a June 5 2023 speech by Joachim Nagel, President of the Deutsche Bundesbank, slide #4, here).
Noting that interdependence forged through international trade can also create “dependencies” and “risks”, Nagel goes onto discuss the critical manufacturing inputs for which Germany relies on China, including rare earth metals and chemical manufacturing components: “In extreme cases, these [rare earths] are sourced from just a single Chinese supplier. The sector of the German economy that is most reliant on China is the chemicals sector… just under 27% of imports of critical industrial goods from China are chemical goods.” Nagel more or less spelled out in this speech the economic calculus informing Germany’s foreign policy decisions around US-China tensions. That Germany is a US ally yet relies so heavily on China for the health of its manufacturing sector creates quite a conundrum for policymakers. Indeed, Nagel specifically spoke to the possibility of a future conflict and brainstormed how Germany might alter its supply chains “[i]n the event of a fundamentally changed risk situation, for example due to geopolitical tensions”.
Paralleling Nagel’s concerns about geopolitical risk, Olli Rehn, Governor of the Bank of Finland noted as follows about the historical trajectory he believes Europe is on:
The geopolitical environment is now changing as rapidly as it did in the late 80s and early 90s. At that time, the Berlin Wall crumbled, the Soviet Union collapsed, Eastern Europe broke free, Europe was united and China was integrated into the world economy. The world became a safer and more prosperous place to live – for a while. Now, sadly, we are moving in the opposite direction, towards a new Cold War and a breakdown in international cooperation. Autocracies like Russia and China are forcibly challenging the rules-based international order. The security policy environment of Europe is being transformed as fundamentally as it was 30 years ago, only this time in reverse.
He further cautioned that financial sector stability should not be “taken for granted”.
Things I’m keeping an eye on:
1. Ukraine war (dam collapse near Kherson, slow progress on peace negotiations).
2. US and European banking sectors, bond markets, equity markets, including Fed and ECB meetings next week. Canada raised rates on Wednesday.
3. Iran’s hypersonic missile test.
4. Canadian wildfires.
5. US Secretary of State Blinken’s plans to visit China, and responses from China. (This is an interesting piece from Chinese state media).