We are facing a turning point in our financial history.

At the end of 2019, instead of a market commentary on the last month, I think it is appropriate to make a more general overview of the economic and financial trends that we have observed over the past year. Such an overview is extremely valuable right now, because over the past year it has already been very clear that the economic cycle is turning. The years of relatively high and stable growth are now behind us. There are too many indications, especially in key economies such as Germany, that the cycle is turning from growth to recession.

Last week, the last meetings of the year were held by both the US Federal Reserve and the European Central Bank. At both meetings, the central banks decided not to change interest rates. In the Eurozone, the ECB interest rate remains at a record low of -0.5%, and in the US, after three consecutive cuts, the Fed decided to leave it at a level between 1.5% and 1.75%. Both the new ECB President Christine Lagarde and the Fed Governor Jerome Powell expressed cautious optimism about future economic trends. That is to say, they expect the economic situation in the US and Europe not to worsen in 2020, but to stabilize and even slightly improve in the case of the US.

Alas, this will most likely turn out to be a completely groundless fantasy. Let's just ask ourselves the question - where will this growth come from? Industrial production in the US has been on a clearly pronounced downward trajectory over the past year. In September and October, it even fell, for the first time since 2016. Not to mention industrial production in Europe. German industry has been in a practical recession for a whole year, and Italian too. In France, there has been growth in 6 of the last 12 months. All this has begun to affect industry in peripheral countries such as Bulgaria since the summer.

Of the three main sectors in the modern economy – industry, services and trade – the first is the one that gives the earliest indications of an impending recession. This is because the industrial sector is extremely capital-intensive. In the structure of production of the entire economy, industrial activities are relatively further away from consumers than the other two sectors. Industry does not offer a finished product, it develops the early and intermediate stages of production of the final products that are offered in the trade sector. Due to these factors, if there is going to be a recession, it is felt first in the industrial sector.

Therefore, judging by the fact that industrial production is deteriorating everywhere, we cannot help but be led to believe that a recession is approaching. Of course, the fact that it is approaching does not mean 100% that it will occur. Central bankers are certainly doing everything in their power to prevent this, having noticeably loosened their monetary policy over the past year. It is precisely in these attempts to prevent it that it is clear that they themselves expect a recession. And they fear it to such an extent that Christine Lagarde, the new president of the ECB, has even begun to criticize countries like Germany and the Netherlands for their relatively "low" levels of government spending.

It is now clear that, according to the ECB, monetary policy tools are not enough to stimulate growth in the Eurozone. More aggressive fiscal measures are also needed, even if this means larger deficits beyond the 3% limit. Lagarde has actually explicitly hinted that it may be time for the Eurozone to rethink its “strict” fiscal rules, which require member states not to have fiscal deficits larger than 3% of GDP and public debt higher than 60% of GDP. Of course, these requirements are not “strict” at all at the moment – they are not respected by almost anyone and have never been respected.

What we see is that the ECB has fallen into a (still quiet) panic and is not sure whether it will be able to prevent the next recession on its own, no matter how much money it pours into the banking system. And the banking system itself is also in a panic. The ECB's negative interest rate policy means that banks literally lose money if they hold excess reserves, i.e. if they do not lend more and more non-stop. The problem is that in 2019 it already turned out that there was nowhere to lend more. The business (or rather credit) cycle reached its peak and lending could not accelerate further. As a result of this dynamic, profits in the sector began to suffer and, worried by this trend, banks began to consider and even impose the unthinkable. Instead of giving, they began to take interest from their customers' deposits.

This is a monumental historical moment in the history of modern banking. In principle, the main competitive advantage of fractional reserve banking (where a bank can only pay out a portion of its customers' deposits at any given time) is that it can offer a profit in the form of interest on deposits. This contrasts with full-reserve banking, where a bank can cover all of its customers' deposits 100% at any given time, but that means it cannot use them to make loans. This is why this type of banking also charges a deposit fee that the customer must pay if he wants the bank to hold his money.

Do you realize what a paradox we have arrived at? Due to the insane policies of central banks and the inherent instability of the modern banking system, we have reached a situation in which banking is both fractional reserve and requires customers to pay a fee (i.e. negative interest) to deposit their money. Of course, for the time being, banks in Western Europe only charge fees on large deposits of large corporations, mostly financial ones. But the trend is obvious. If monetary policy continues in the same direction and some radical reform of the system does not occur, very soon we will all have to pay fees on deposits. Fees for the "storage" of money that is not even there, because banking is fractional reserve, which in the Eurozone amounts to only a few percent of all deposits due.

If we look at what is happening overseas, we see that stocks are at record highs. Financial data from the Federal Reserve shows that the ratio of the price of shares of American companies to the price of their assets has fluctuated between 1.25 and 1.30 over the past year. For comparison, the historical average level of this indicator is between 0.7 and 0.8. This means that currently the shares of American companies are extremely overvalued. And this is not new - they have been at these levels for the past 3 years.

One thing is clear. We are living in unprecedented times in the financial history of human civilization. The coming year 2020 could be a turning point, especially if the negative economic trends we observed in 2019 continue to deepen. In the US, the situation is not yet so critical, but in Europe, the political and financial elites will face an extremely difficult decision. And unfortunately, they do not seem ready to make the right choice.

If the ECB continues to print money and pressure governments to spend more, Europe is likely to become a second Japan. That means the Eurozone and even the entire European Union will be doomed to economic stagnation. The biggest danger facing the EU right now is that the next decade could be a “lost decade.” Instead of one or two years of severe crisis, European elites seem to prefer 10 years of slow but steady deterioration of the economic health of the union. The mantra of “stability” takes on a whole new, twisted meaning.

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