While the ECB Plays Weak – You Should Play to Win

Tennis is the most beautiful of sports. Wimbledon…strawberries and cream…what could be better?

But as most keen amateurs will know, tennis is a game that can quickly descend into an ugly affair.

You see, unlike most sports, tennis isn’t about winning, so much as it is not losing. Various studies suggest that between 65% and 95% of shots are lost, not won. A typical rally ends with a player hitting it into the net or long passed the baseline. And that has a profound effect on a player’s psychology.

Weak players (and alas I count myself among them) can bring the whole game down. Just think about it. If you know that all you need to do is keep the ball in play and wait for the opposition to miss, then that’s exactly what you do. It’s a game that can bring out the absolute worst in you.

And it’s not just tennis. Exactly the same psychological and technical factors are bringing Europe into disrepute and farce right now.

The European Central Bank’s recent decision to descent into weak banking is an attempt weaken the game. The only thing is, when you’re playing against a class player, you won’t get away with it. And I think there is a very interesting play on this that I’d like to tell you about today…

Europe goes on the defensive
Let’s face it, as the EU developed, it was widely acknowledged that the peripheral European states were largely based on weak macro-economic models. Weak currencies, weak government and weak economic programmes were set to be replaced by the stronger German ethos.

Germany’s Bundesbank was specifically chosen as the role model. With Germany’s winning formula, the rest of the players were expected to up their game.

And yet, only a couple of decades into the whole thing, things seem to be descending into farce. Rather than Germany providing the impetus to play well, what we see is Germany dragged down into a weak game.

Last week’s decision by the ECB to lower interest rates into negative territory, and the fact that they’re now considering their own QE programme, is surely a move in the wrong direction.

This is precisely the opposite of what was supposed to happen!

Where it all went wrong
For decades the Germans led the way on sober and strong central banking. Make no mistake, as Western Germany absorbed Eastern Germany, painful transitions were made. Labour market reform and reform of the welfare state was forced on the populace in proper Teutonic form.

If Germany could face structural change, so could the rest of Europe. That was the plan.

Yet, when it comes to actually playing the game, what we’ve seen is something quite different.

Latin Europe, and I’m thinking specifically of France, Spain and Italy, don’t want to play the beautiful game.

In the light of structural reform, last week we saw the French air traffic controllers go on strike. And that’s on top of the ongoing rail strike actions and all the rest of it. This is not what was supposed to happen.

We also saw the ECB succumb to another bout of classic weak play. The central bank is now well entrenched in feeble play. Lower the currency, set up for inflation and give the punters what they want!

Long term readers will know that I love France. Yet, here I see a country that simply refuses to roll with the punches. Well over half of GDP is controlled by the State — and that’s by law! While most of the world accepts the fact that we all have to retire later, these guys swim against the tide.

There’s absolutely no will to reform. No need to play the game as it was envisaged.

And this is what it all boils down to…

Germany’s DAX vs the French CAC
Notice how at the start of the chart (5 years ago), both the French and the German markets traded in sync. Yet in later years, Germany has roared ahead. In fact, this is a chart that I’ve drawn your attention to before.

The fact is, Germany is a class player.

Yes it’s true that the Latin countries have dragged Germany into playing its own weaker game, but the problem is, this only serves to highlight Germany’s strengths.

In early 2012, I suggested that there was a relatively risk free way of playing this. A market neutral strategy of shorting the French CAC while going long the German DAX. And given what’s happening, the trade is working out great.

With the European Central Bank increasingly turning Latin, I see absolutely no reason to change tack.

As with tennis, central banking can be dragged down to the lowest common denominator. Only thing is, once you come up against a strong player, the weak strategy is flawed.

Whilst it’s an ugly game, it does give us the opportunity to continue to profit.

In the meantime, have a happy Wimbledon. Unlike the rank amateurs in central banking, at least these guys are playing to win. Amateurs, step aside. This is a game for the grown-ups.


Bengt Saelensminde
For Markets and Money

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