The Devil Is In The Details: Trump Trade Cracks Emerge

This special guest commentary was written by our friend Mike O'Rourke of JonesTrading


The Devil Is In The Details: Trump Trade Cracks Emerge - Trump drunk bull 11.30.2016


Yesterday the first legitimate signs of the execution risks related to “Trump Trades” emerged in the market.  Some risks were associated with policies that may not come to pass, and some were associated with policies investors were fearful would come to pass. Republican Senators have begun to revolt against the Border Adjustment Tax (BAT).


In turn, political analysts are modifying their models to try to find a way to find the revenue to finance corporate income tax cuts. The stark reality is that it is essentially impossible to get to the Congressional Republican’s 20% rate. There is no doubt the President’s 15% rate is a near impossibility. These rising doubts may have resulted in pushing President Trump closer to the Congressional Republicans. 


Although it was lukewarm, in an exclusive Reuters interview today, for the first time, the President expressed approval of a Border Adjustment Tax. The headline hit late in the day and sent a number of retailers and apparel related companies lower because they are the largest importers in the country (chart below).


The Devil Is In The Details: Trump Trade Cracks Emerge - bat importers


The market also responded to reports that the President’s aggressive infrastructure agenda will likely be delayed until next year.  It was exactly a week ago that JonesTrading hosted a call with Washington Lobbying firm Williams & Jensen. 


On the call, W&J noted that the legislator on Capitol Hill most closely aligned with President Trump is Democratic Senate leader Chuck Schumer. That gives an indication of how far down the priority list infrastructure is. We summarized the W&J comments from last week,


Another key area of note is the plan for infrastructure spending.  While it is an issue high on the President’s priority list, many of the Republicans in Congress view it as simply another form of spending and shirking fiscal responsibility.”


We noted earlier in the week that with the exception of steel companies, many of these names have begun to pull back. There was widespread weakness among these shares with our infrastructure basket losing 4.2% on average today (chart below).


Interestingly, while these policy problems influenced performance in their defined spaces, they did not manifest in the broad market today as another round of new highs were registered. That being said, the developing trend appears to be that as more details emerge, so do more challenges. There’s a reason they say “the devil is in the details.”


The Devil Is In The Details: Trump Trade Cracks Emerge - infrastructure intra


This is a Hedgeye Guest Contributor research note written by Michael O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.


The Devil Is In The Details: Trump Trade Cracks Emerge - disclaimer

Why Does the Fed Keep Lowering Its Unemployment Threshold?

This special guest commentary was written by our friends Benn Steil and Emma SmithCouncil on Foreign Relations


Why Does the Fed Keep Lowering Its Unemployment Threshold? - steil fed


For years, Fed watchers have been getting antsy as unemployment falls toward NAIRU — the Fed’s estimate of the bound below which inflation rises. But as shown in the graphic above, each time unemployment has threatened to break through NAIRU the Fed has lowered NAIRU rather than raise interest rates. Why?


The answer would appear to be in wage growth. As shown in the small inset graph, there is a strong relationship between wage growth and slack in the labor market—as measured by the difference between unemployment and the Fed’s NAIRU estimate. What this suggests is that the Fed has consistently overestimated wage growth, leading it to lower NAIRU when new wage data come out.


As the yellow highlighted part of the graphic shows, we appear to be at a turning point. Unemployment is now near the bottom of the Fed’s NAIRU range. This supports the case for Fed rate hikes.


But beware. Though the Atlanta Fed measure of wage growth remains strong, at around 3.5 percent, it is slowing. Should it fall to 2.5 percent, we can, on past experience, expect the Fed to lower NAIRU again, such that its measure of labor market slack rises from zero to as much as 0.8 percentage points. That would mean putting rate hikes on hold.


This is a Hedgeye Guest Contributor piece written by Benn Steil and Emma Smith and reposted from the Council on Foreign Relations’ Geo-Graphics blog. Mr Steil is director of international economics at the Council on Foreign Relations and author of The Battle of Bretton Woods. It does not necessarily reflect the opinion of Hedgeye.

Inside Trump's Wall Street Reform Efforts: How to Fix Dodd-Frank Regulations

This special guest commentary was written by our friend Christopher WhalenKroll Bond Rating Agency


Inside Trump's Wall Street Reform Efforts: How to Fix Dodd-Frank Regulations - wall street sign 2


Recent statements from the Trump Administration regarding reform of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 have generated a number of questions from investors.


Kroll Bond Rating Agency (KBRA) opined last November ("Will the CHOICE Act be the First Trump Reform Legislation?") that our view of the likely reform agenda includes congressional passage of the Financial CHOICE Act sponsored by House Financial Services Committee Chairman Jeb Hensarling (R-TX).


Inside Trump's Wall Street Reform Efforts: How to Fix Dodd-Frank Regulations - whalen callout 2 6 17


That view has not changed. However, the dynamic political environment has generated some specific reform proposals.

The Volcker Rule

The Volcker Rule refers to the part of the Dodd–Frank Act originally proposed by former Federal Reserve Chairman Paul Volcker to restrict United States banks from making certain kinds of speculative investments for their own accounts. More important, the Volcker Rule addresses the conflict of interest that arises when a bank acts on behalf of a customer, on the one hand, and trades for its own account, on the other. KBRA believes that the basic goal of the Volcker Rule remains sound, but needs to be amended in two respects:


  • First, the administrative requirements of the Volcker Rule are byzantine and should be greatly simplified as part of a larger review of rules regarding liquidity and other Dodd-Frank and Basel III regulations. The process for implementing and reviewing compliance with the Volcker Rule is excessively complex, costly, and burdensome for banks.
  • Second, we believe for reasons related to market liquidity that the restrictions of the Volcker Rule should be confined to the depository and that affiliates of bank holding companies such as broker dealers and funds should be allowed to trade for their own accounts. Given adequate safeguards to isolate the depository from conflicts between the duty to the customer and the organization, allowing broker-dealers and other affiliates to trade for their own accounts will alleviate the market liquidity concerns that have existed since the Volcker Rule was implemented.

What Is a "Systemically Important" Bank?

National Economic Council Director Gary Cohn, who is evolving into the Trump Administration’s point man for regulatory reform, has suggested modification to the Financial Stability Oversight Council’s (FSOC) authority to designate non-banks as systemically important financial institutions (SIFI), and to the Dodd-Frank Act’s Orderly Liquidation Authority (OLA).


Cohn told the Wall Street Journal that both FSOC and the OLA would be reviewed. Perhaps most notably, Cohn stated: “We don’t think non-banks should be SIFIs.”


  • CompassPoint LLC writes: ”These comments reinforce our belief that the non-bank SIFI insurers—[Prudential, AIG, and MetLife]—will be de-designated and that the odds of additional non-bank SIFI designations in this administration are effectively zero.” KBRA agrees and believes that whether or not legislation is passed, the FSOC process isessentially moribund from today onward. Indeed, we expect that the litigation involving the SIFI designation of MetLife will likely be dropped by the Trump Treasury.
  • Regarding the OLA, we believe that as with the Volcker Rule, the big problem with the OLA is the overhead involved in compliance, including “living wills” and other onerous regulatory requirements. As KBRA has noted previously, the Federal Deposit Insurance Corporation is under no requirement to utilize living wills in resolving a large financial institution under Dodd-Frank. While the legal authority to take over a troubled financial institution is very important to avoiding a repeat of the Lehman Brothers debacle, the FDIC and other regulators should do any planning unilaterally and in private.

The Biggest Challenge For Financial Reform

Perhaps the biggest change for all financial services companies and professionals in 2017 is that the political narrative regarding financial regulation has shifted from a punitive focus with anti-business effects to a more traditionally conservative agenda focused on growth and jobs. By easing the political headwinds against banks and non-banks alike, the Trump Administration can greatly improve liquidity in the financial markets and enhance the opportunities for economic growth.


An important point to make regarding the regulatory response to the 2008 crisis is that a lack of liquidity, not capital, was the proximate cause of the catastrophe. Yet since 2008, regulators and policymakers have focused on increased capital for banks and restrictions on risk taking as a general panacea for preventing a future crisis.


Many of these requirements have been accompanied by regulatory requirements such as those of the Volcker Rule and the FSOC SIFI designation that, in our view, fail to address the problems that spawned them.


In general, KBRA believes that modifications to the Dodd-Frank law that lessen the regulatory burden but address the underlying causes of the crisis will be positive for investors. Any changes to the current regulatory system need to de-emphasize the mechanistic use of capital as a catch-all response to the financial crisis and instead construct policies to prevent the reoccurrence of acts of financial deception, particularly the use of hidden leverage to enhance short-term financial returns, that ultimately caused the 2008 financial crisis to occur in the first place.


This is a Hedgeye Guest Contributor piece written by Christopher Whalen of Kroll Bond Rating Agency. Whalen is a Senior Managing Director in the Financial Institutions Ratings Group. Over the past three decades, he has worked for financial firms including Bear, Stearns & Co., Prudential Securities, Tangent Capital Partners and Carrington. This piece does not necessarily reflect the opinion of Hedgeye.

Game Theory: Is Trump Truly Crazy Or Just Playing Chicken?

This special guest commentary was written by our friend Richard Peterson M.D., MarketPsych


Game Theory: Is Trump Truly Crazy Or Just Playing Chicken? - chicken make america


"To achieve their mating goals, male elephants will sometimes play games of chicken, with one individual essentially giving the impression that he is crazy and has become an irrational player in a game premised on shared rationality and predictability."
–Professor David Barash, Op-Ed in the NYTimes, 2011

Happy Chinese New Year 2017, year of the Rooster! 

Fittingly, this Year of the Rooster corresponds with a surge in a cock-inspired game in international negotiations: playing chicken.  

As a young man I occasionally stood on the bridges across the Rio Grande, practicing Spanish and watching Mexicans commute to work in the United States.  They bagged their clothes, paid a peso or two to a man with an inner tube, and were gently pulled across the river under the eye of inert border patrol agents. U.S. customs wasn't apparently concerned enough to intervene. 


I myself climbed under the fence or waded the river a few times out of convenience or curiosity.  Even the Laredo, Texas INS chief's nanny was well-known to commute to work that way.  In subsequent years the border has obviously tightened.  And now we're hearing about The Wall, whose conception has badly punished the Mexican Peso and local stocks.


As active investors it is our job to predict trends and reactions in global economies and markets.  Donald Trump's spontaneity has introduced a degree of unpredictability to our work.  His negotiations around trade agreements, immigration policy, tax policy, military arrangements (NATO), and budgetary allocations are all going to be significant  to the markets over the next year.  Whether one agrees with Trump's proposals or not, it's important to know how he will pursue them, when he will go full force, and when he might back down.  


Game Theory: Is Trump Truly Crazy Or Just Playing Chicken? - marketpsych trump

Trump's tactics are familiar - and perhaps predictable - to students of game theory. Today's newsletter looks at this important topic - one we have addressed previously - the psychology of negotiation and playing chicken.  Later we look at a turn in U.S. Dollar sentiment around the U.S. election and its aftermath.

Game Theory in the Real World

John Nash is the subject of the Academy Award-winning movie "A Beautiful Mind" and the father of Game Theory involving multiple equilibria in non-cooperative games - exactly what we need to understand the psychology of playing chicken.  


In this past newsletter on the Iranian pursuit of nuclear weapons, we discussed how Professor David P. Barash explained the game theory of young male elephants as akin to playing chicken. When a player in a game is in a weaker position, the only way to get additional power is to fake crazy like an elephant in "musth".


Donald Trump may be in a position of "low power" (from a legal perspective) as he begins to renegotiate U.S. trade agreements.  Yet there is a businessman's logic to his negotiation tactics.  

Trump's Negotiation Style (or Playing Crazy)

In order to predict the future, we need to understand Trump's style, regardless of whether we agree with his policies.

To quote at length from the op-ed in the New York Times that opened this newsletter:


"It's a tactic that works surprisingly well, because male elephants can in fact become temporarily 'crazy'. One of the most terrifying sights in the animal world is an elephant in a state of must: Huge bulls, oozing a weird, foul-smelling, greenish glop from glands near their eyes, behave with violent abandon, taking risks and defying the basic rules of pachyderm propriety (and also giving rise to the term "rogue elephant"). Facing an elephant in must, other elephants — not to mention people — are well advised to get out of the way."


Dr. Barash explains that by playing chicken - as Donald Trump may be inclined to do as he renegotiates terms of existing trade agreements - low-power players can extract additional concessions due to their hardliner stance.  As he puts it, "The trick to winning is for one player to convince the other that under no circumstance will he or she veer off course."  Dr. Barash continues, "Another tactic, favored by the strategist Herman Kahn, is to "throw out the steering wheel," to demonstrate that you are locked into a certain path and can't swerve."


When playing chicken it is best to convince your opponent that either:


  1. You have no alternative course of action and so CANNOT compromise ("my constituents won't let me back down"), or
  2. You are stone-cold crazy and could care less about the consequences to yourself ("I will take you down with me if that's how it has to be!"). 


Both of these strategies increase the negotiating power of a lesser player, but they also presume a rational analysis of the situation by that player.  Sometimes your opponent truly is crazy, and you will always lose when playing chicken with such an opponent (as will they, but they won't care).  If Trumps keeps his competitors guessing what type of crazy he is, then he has already won.


Per Prof. Barash:  "In either case, whether you're confronting a rogue elephant or a rogue nuclear state, the advice is the same: stop playing the game. Avoid the elephant or shoot it; politically isolate the rogue state or use military force to disarm it."  But Trump won't let his opponents stop playing the game. They are locked in, and in his early negotiations, he has the advantage of unpredictability.


Trump's negotiation style works well when the bottom line of every negotiation is money.  (Who cares about pride in business if there is money to be made?)  But in international negotiations, national pride can be wounded (Mexico this week and perhaps China later this year).  When pride is wounded, national dignity often trumps (-sorry-) economic self-interest. 


In terms of sheer political survival, it is rational for a government to appease its own public opinion about being bullied by playing chicken until the collision.  Trump himself has staked such a stance in his blocking of free trade agreements such as the Trans-Pacific Partnership (TPP), perhaps to his negotiating advantage.

But the real question remains unanswered - is Trump actually crazy or just playing crazy like an elephant in musth?  As a psychiatrist I can't ethically answer that question.  From this past week it appears that he will be consistent with his campaign promises.  And in that sense there will be less unpredictability than his twitchy Twitter finger would suggest.  

U.S. Dollar Sentiment

The election of Donald Trump prefaced surge in positive sentiment about U.S. stocks and the U.S. Dollar.  A sentiment view of the U.S. Dollar is below.


Game Theory: Is Trump Truly Crazy Or Just Playing Chicken? - marketpsych sentiment


Note that the U.S. Dollar has stabilized at a level well-above it's low of the pre-election period, so it's not as if the market doesn't trust Trump.  But the original enthusiasm has faded as we settle into the messy business of negotiating and governing.  

The month of February may set the sentiment tone for the year as we come to understand whether Trump has a method to his perceived madness, or whether conflict and turmoil will be a baseline state for the next four years.

Houskeeping and Closing

Just as Wall Street climbs a "Wall of Worry," we are at all-time highs in the equity markets.  A bit of stress and a shake-up of the system may be just what the U.S. needs.  And unless some clear method is discerned in the madness, it's likely that the perception of madness IS the preferred method of the next four years under Trump. 


As Trump himself noted in his 1987 book, “The Art of the Deal,” and paraphrased from the WSJ his style is to “aim very high,” and then to keep “pushing and pushing to get what I’m after.”  “Sometimes I settle for less than I sought,” he continued, “but in most cases I still end up with what I want.”

And always remember:  Playing crazy isn't the same as being crazy.  In fact, it can be quite the opposite if it gets you what you want.

We love to chat with our readers about their experience with psychology in the markets.  Please send us feedback on what you'd like to hear more about in this area.  Read more about individual psychology in our books "Inside the Investor's Brain" (Wiley, 2007) and "MarketPsych" (Wiley, 2010).  Market psychology and sentiment-driven market patterns are examined in our newest book "Trading on Sentiment:  The Power of Minds Over Markets" (Wiley, 2016).

If you represent an institution, please contact us if you'd like to see into the mind of the market using our Thomson Reuters MarketPsych Indices to monitor real-time market psychology and macroeconomic trends for 30 currencies, 50 commodities, 130 countries, 50 equity sectors and indexes, and 10,000 global equities extracted in real-time from millions of social and news media articles daily.

Happy Year of the Rooster!
Richard Peterson M.D. and the MarketPsych Team


This is a Hedgeye Guest Contributor piece written by Dr. Richard Peterson. Peterson is CEO of the MarketPsych group of companies where he leads MarketPsych's data and asset management division. He has trained thousands of professionals globally to leverage behavioral insights. He is a board-certified psychiatrist and author of Trading on Sentiment.This piece does not necessarily reflect the opinion of Hedgeye.


Guest Contributor: Is The Trump Honeymoon Over?

by Mike O'RourkeJonesTrading


Guest Contributor: Is The Trump Honeymoon Over? - honeymoon


President Trump appears very intent on fulfilling his “Contract with the American Voter.” One has to appreciate that fact that even Wikipedia notes:


“Election promises may be instrumental in getting an official elected to office. Election promises are often abandoned once in office.”


Thus far, it is clear President Trump has not abandoned anything and is attempting to fulfill his campaign promises to the best of his ability. When the actions the President take are pro-jobs, deregulatory, or indicate fiscal spending, the market has celebrated.


Guest Contributor: Is The Trump Honeymoon Over? - o rourke callout 1 31


The President’s executive order banning people from Iran, Iraq, Libya, Somalia, Sudan, Syria and Yemen from entering the US is clearly the most controversial action the President has taken. And now, the same corporations that were sitting down with the President over the past couple of weeks are making public statement distancing themselves from the President’s ban.

Is America On The 'Right Track'?

Yesterday's market action might be an indication that there is concern that Trump will follow through on his more divisive measures, thereby ending the financial markets' honeymoon with the new President.


Ironically, Rasmussen Reports released its last week’s US Right Direction/Wrong Track polling data and right track jumped 9 points to its highest level in 12 years (chart below). It will be interesting to see next week’s reading. Yesterday, the equity markets were mildly troubled as the S&P 500 registered its worst performance of the New Year and the Russell 2000 returned to negative territory year to date.


Guest Contributor: Is The Trump Honeymoon Over? - rasmussen

Trump's Executive Orders

President Trump’s latest executive order signed yesterday indicated that for any single regulation an agency enacts, two must be eliminated. The 1 for 2 deal is certainly unique in its construct and is a pro-business measure most market participants support. Trump’s depiction of the order is important.


“We want to end the unfairness between small and big business caused by regulation, regulation that's actually been horrible for big business but has been worse for small business. Plus, small business can't hire the kind of talent that the big businesses can hire, so it's really very unfair. Big business so often can afford compliance with the costly regulations, but I don't want them to. I want them to build new plants, and sell more cars.”


It is imperative to recognize that these regulations often serve as barriers to entry, protecting big business. While we recognize the post-election rising tide has lifted all boats, the market has recognized the difference within the financial sector. Since the election, S&P 600 Small Cap Banks have outperformed S&P 1500 Banks, which have outperformed the large cap Banks in the S&P 500 Diversified Financials (chart below).


Guest Contributor: Is The Trump Honeymoon Over? - sp 1500 sp 500 fin

Which is It: Stock Market "Bubble" or is it "Not Going Down"?


Thus far, the market has treated everyone as winners to some degree, but when its starts discriminating between winners and losers, investors will begin to identify who has benefited from the barrier to entry regulation created, and those who will benefit from a friendlier environment. In discussing the new executive order yesterday, the President also commented on the equity market. Trump noted:


“The stock market has gone up massively since the election. Everyone's saying -Oh, the market will go down. I said -The market's not going down. You know, the smart people know me. The business people know me, they know what I'm about. So the market went massively up. In fact, when I was elected, a lot of the really smart people went out and bought a lot of stock and they've been rewarded.”


There is no doubt that investors who bought stocks immediately after the election have been rewarded. The President certainly feels different than he did during the debate in September when he argued:


“And believe me: We're in a bubble right now. And the only thing that looks good is the stock market, but if you raise interest rates even a little bit, that's going to come crashing down. We are in a big, fat, ugly bubble. And we better be awfully careful.”


It is not surprising that the President has confidence in his own abilities, but going from “bubble” to “not going down” is intellectually inconsistent and reeks of overconfidence, which is deadly in markets. While confidence sells on television and on the campaign trail, financial markets don’t care what any of us think.


This is a Hedgeye Guest Contributor research note written by Michael O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.


Guest Contributor: Is The Trump Honeymoon Over? - disclaimer

Guest Contributor: Why Europe's Economic Woes Won't Be Fixed By Inflation

by Daniel Lacalle

Guest Contributor: Why Europe's Economic Woes Won't Be Fixed By Inflation - draghi euro balloon


Inflationists are happy. Prices rise to five-year highs and some rub their hands with the idea that their grand plan to create inflation by decree is going to be a success.


Inflation, the tax of the poor, applauded by no consumer anywhere ever.


The discourse of inflationists is simple and, therefore, farcical. If inflation increases, the debt “deflates”, entering into a process of deleveraging as liabilities of states, companies and families loses value each year. “If inflation rises to 4%, every year, we have 4% less debt,” I was told in a television program. I thought “great, and if it’s 50% in two years we have no debt.” A joke.


Guest Contributor: Why Europe's Economic Woes Won't Be Fixed By Inflation - lacalle market realist

The Eurozone's Problems Are very different and won't be “solved” by inflation


New Eurozone debt issuances in 2017 are estimated at €20 to €40 billion, a total of € 885 bn to €900bn in 2017, according to ING and Morgan Stanley, respectively.


The Eurozone´s debt repayment capacity, according to Moody’s, has reduced to 2007 levels due to accumulated deficits, deterioration in cash flows and the creditworthiness of public and private agents.


The problem with the simplistic argument of consensus inflationism is that it does not happen. From Deutsche Bank to Morgan Stanley, many are warning of the risk of “trusting” in an inflationary exit to the liquidity trap.


  • With rising inflation, real interest rates and interest expenses rise, in countries that do not reduce debt in absolute terms.
  • Tax revenues do not grow with inflation because overcapacity remains – 20% in the Eurozone - most of the inflation increase comes from higher energy costs, and this creates weakness of margins and revenues. Anyone who thinks that real wages are going to grow at or above inflation with the stock of unemployment that still exists in the eurozone, must be joking.
  • Input costs increase more than sales, because of overcapacity, aging population, and higher imported oil and gas prices. Imports rise, and ability to pass-through to final prices diminishes.
  • “Existing” debt -stock- reduces its value due to inflation, but deficits and interest expenses rise.


If we take the refinancing needs of the Eurozone, close to € 1 billion a year, and assume an increase in inflation to double from current levels (2.2%), any serious analysis that takes into account the particularities of the European economies can easily see that the effect on the cost of financing of economic agents and the increase in deficits exceeds, by a ratio of 1.05 to 1, the alleged “benefit” of devaluing the stock of debt.


Guest Contributor: Why Europe's Economic Woes Won't Be Fixed By Inflation - lacalle callout 1 30


In fact, low prices have been a very relevant factor in cementing the Eurozone recovery. If it were not for low CPI, it would have been much more challenging for families to endure the bubble-led crisis and subsequent real salary decrease and unemployment rise. Anyone who thinks that inflation would have prevented the crisis is ignoring the factors behind the Eurozone recession. The questionable Phillips curve link between CPI and unemployment was debunked decades before.


Of course, the inflationist alchemist is confident that these risks – which they cannot deny – will be canceled-out by the European Central Bank’s monetary policy, which will have to repurchase everything that is issued to prevent real rates from rising alongside inflation.

Welcome to the recipe for stagflation

When artificially manipulated rates fall below real inflation, credit growth collapses, real productive investment falls and, with it, the velocity of money. In fact, the only investment and credit that is encouraged by this policy is high risk and very short term oriented to compensate for the difference between reality and manipulated rates.


The truth is that the Eurozone cannot get out of the liquidity trap when 90% of net funding needs are used to cover deficits that pay for current expenses. We saw it when inflation in the Eurozone was 3 to 5% … But then, debt and annual structural deficits were much lower.


Expenses rise, due to inflation, but revenues don´t increase the same way, due to structural circumstances of productivity and weak margins.


SMEs, 90% of companies in the Eurozone, cannot transfer these price increases to their margins – and thus their tax payments- because inputs rise more than revenues. The same happens with wages.


If we add a structure of “big companies” in Europe comprised of industrial conglomerates with very low productivity, poor returns and high external indebtedness due to foreign acquisitions, their sensitivity in profits and tax payment to inflation increases is very low. The estimates of the Tax Foundation and other studies show that inflation increases has a very poor translation to profits. Almost zero, even negative.


Families in Europe have managed to reduce their indebtedness admirably in these years. And the vast majority of their wealth is in deposits. If we think that an aging population is going to buy more in real terms because prices rise, we have not learned anything from the evidence of the past. But some will say that this time is different.

What's Wrong With The E.U.

The problem with the Eurozone is that it is trying to solve structural problems with any measure except the one that fixes the perverse incentive that perpetuates stagnation. The constant transmission of wealth from the efficient and the saver to the indebted and inefficient.


The EU tries to fix the economy without touching the mechanisms that slow it down. High government spending, low productivity and poor competitiveness.


The European Union is increasingly burdened with fixed costs and unproductive spending, putting stumbling blocks to the economy in favor of more white elephants and bureaucracy. Inflation by decree is not going to change it. It will extend it.


But many will tell you that it is for your own good.


This is a Hedgeye Guest Contributor research note written by economist Dr. Daniel Lacalle. He is the author of Life In The Financial Markets and The Energy World Is FlatThis piece does not necessarily reflect the opinion of Hedgeye.