Two weeks ago, on one of the slides in a Morgan Stanley presentation, we found something which we thought was quite disturbing. According to the bank's head of EMEA research Huw van Steenis, while in Davos, he sat "next to someone in policy circles who argued that we should move quickly to a cashless economy so that we could introduce negative rates well below 1% – as they were concerned that Larry Summers' secular stagnation was indeed playing out and we would be stuck with negative rates for a decade in Europe. They felt below (1.5)% depositors would start to hoard notes, leading to yet further complexities for monetary policy."
As it turns out, just like Deutsche Bank - which first warned about the dire consequences of NIRP to Europe's banks - Morgan Stanley is likewise "concerned" and for good reason.
With the ECB set to unveil its next set of unconventional measures during its next meeting on March 10 among which almost certainly even more negative rates (for the simple reason that a vast amount of monetizable govt bonds are trading with a yield below the ECB's deposit rate floor and are ineligible for purchase) the ECB may cut said rates anywhere between 10bps, 20bps, or even more (thereby sending those same bond yields plunging ever further into negative territory).
As Morgan Stanley warns that any substantial rate cut by the ECB will only make matters worse. As it says, "Beyond a 10-20bp ECB Deposit Rate Cut, We Believe Impacts on Earnings Could Be Exponential."
Which brings us the the punchline: according to Morgan Stanley, a fellow bank, the biggest threat to its largest European competitor, Deutsche Bank is not its unquantified commodity loan exposures, nor its just as opaque exposure to China, nor its massive derivatives book, not even its culture of rampant corruption and crime which have resulted in constant top management changes over the past several years, but the deflationary challenges to profitability - specifically, "Risks to Trading/Markets Revenues and Due to Negative Rates" imposed by none other than the European Central Bank!
In other words, according to Morgan Stanley the biggest threat to the profibatility, viability and outright existence of the most leveraged commercial bank in the world, is none other than ECB president Mario Draghi...
... who will almost certainly unveil even more negative rates in two weeks time, and in doing so will unleash another round of selling in European bank securities, which will further tighten financial conditions, which may force even more "desperate" ECB intervention and so forth in a feedback loop, for the simple reason that Draghi appears to not realize that just like Kuroda, he himself is the cause of asset volatility and European bank instability.
Which, incidentally, is precisely what Bundesbank president (and ECB member) Jens Wiedmann warned against. As WSJ reports, Weidmann expressed reservations Wednesday about further expansionary monetary policy to combat very low rates of inflation in the currency bloc.
According to prepared remarks to present the annual report of the Deutsche Bundesbank, which he heads, Mr. Weidmann said "it would be dangerous to simply ignore" the longer-term risks and side effects of loosening already highly accommodative policy.
As the WSJ writes, "the comments from perhaps the ECB's most outspoken critic of very accommodative policy provide further evidence that ECB head Mario Draghi may have a tough time garnering unanimity for any effort to further expand the central bank's accommodative monetary policy."
Still, Draghi may well get his wishes: after all, despite the ongoing conflict between the two central bankers, so far Draghi has gotten absolutely everything he has gotten, from QE to NIRP, over Weidmann's loud objections. The WSJ further adds that the ECB is expected to cut its deposit rate further into negative territory beyond the minus 0.3% where it sits now, as well as expanding its bond buying program beyond the EUR60 billion a month of mostly government bonds that it has purchased since last March.
The two are linked: for the ECB to expand QE - now that the NIRP genie has been released - it will have to cut rates or else it will run into liquidity limitations and an inability to procure the desire bonds.
Worse, due to the central bank's voting rotation system, Mr. Weidmann won't have a vote at the March meeting.
On a separate topic, Weidmann also criticized efforts to abolish the EUR500 bank note and presented a 22-page report defending the use of cash, pushing back against proposals that German policy makers worry could be used to cut interest rates more deeply in the euro area.
Specifically, Weidmann warned that abolishing the EUR500 note could damage citizens' confidence in the single currency. "If we tell citizens the bank notes they currently hold are not valid, that would impact trust," Mr. Weidmann said.
Weidmann also ridiculed the "fantasy" that cash might be abolished altogether to make it easier for central banks to cut interest rates further. "In my view this would be the false, disproportionate answer to the challenges," he said.
Well, that's what many said about the ECB's QE, which many years ago was, correctly, seen as monetary financing and thus banned by Article 123. Everyone knows that happened next.
But going back to NIRP, the question then becomes: is Mario Draghi really so naive and confused not to realize that the more negative and Net Interest Margin crushing rates and conditions he unrolls, the worse Deutsche Bank's (and all other European banks') fate will be.
And then this question in turn is transformed into a more sinister one: since Draghi most certainly does understand that impact on bank profitability from excessively negative rates (as virtually every bank from DB to MS to BofA has warned in recent weeks), is he engaging in this escalation of negative rates with an intent to harm Deutsche Bank on purpose?
Because should Draghi cut rates on March 10 and send DB's stock price to fresh record low, and its CDS to all time highs, the comparisons to Lehman will get every louder, at which point the self-fulfilling prophecy may become a reality.
And not just due to those two factors. Recall that in the bankruptcy of Lehman it was a former Goldmanite who ultimately decided to pull the plug on the bank - US Treasury Secretary Hank Paulson. By doing so, he unleashed the biggest bailout of the banking system in history, and what may have been the most lucrative period of all time for Goldman bankers as well as the greatest wealth transfer in human history.
That period is ending, so it may be time for another wholesale, global bailout. Just one thing is missing: the "next Lehman" sacrificial lamb whose failure will be the catalyst for the next mega bailout of everyone else who will survive. And since this bailout will involve the paradropping (both metaphorical and literal) of trillions in paper or digital money, central banks may just get the inflation they so desire.
As for the former Goldmanite pulling the switch this time, well we already know who it is: Mario Draghi.