MTC 16 : Portfolio Channel

MTC16 is the last of the new list of MTCs (advanced from Mathews et al. 2013) and is based on liquidity preference models of Monetarism (2.3.4) and Keynesianism (2.3.3) combined with CAPM-derived preference models and other models based on return on assets. It comprises all real economy effects that arise from portfolio changes. Mario Draghi, the cur-rent ECB President, has recently termed the channel ‘broad portfolio balance channel’

(Draghi 2014), indicating that its relevance is in fact also much recognized by the ECB.

The ‘broad portfolio balance channel’ can activate monetary transmission in many different ways while being guided by dynamic demand and supply of assets. MP plays a key role here by providing an initial nucleus and structure to asset market’s return expectations, again via modulations of the interest rate and quantity of money and the timing and amount of steri-lized and non-steristeri-lized, cash-effective and non-cash-effective, operations. For example, if

‘low risk’ assets are purchased by the ECB from investors (e.g. OMO, non-sterilized QE) who subsequently substitute their portfolios with new financial products with a higher risk ac-companied by a prospect of better returns (Draghi 2014) it can have significant impact on aggregate economic decision making. Operation of the ECB may shift demand for liquidity, holding money, and all financial products comprising equity in many ways. Lateral MTC branches are given: e.g. for MTC3,4,6,9 due to shared equity and stock market mechanisms.

Major portfolio decisions comprise whether to engage in (1) monetary assets (lend-ing/borrowing market) (2) equity (stocks, other shares), (3) bonds (corporate and govern-ment), (4) derivatives, options, forwards, and other financial hedging instruments; these can be subdivided into (a) decisions to invest domestically in the EMU or (b) abroad.

MTC16 research describes and models the influence of MP on all combinations of relative shifts of above portfolio items and their respective monetary transmission in the economy.

Indicators for MTC16 are volumes and yield curves of MTC-effective financial instruments.

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Yields of bonds, monetary assets, and debt securities tend to decline at a low MRO while equity is on the rise, empirically validated: EMU yields of bonds and money are falling at low MRO rates (6 Figure S15), equity prices (Figure 77) and volumes (Figure 76+78) soar.

Equity funds balance sheets act as an economic-sensor of core trends (see Figure 76): e.g.

the volumes of ‘shares and other equity’ reveal and predicted the trends of the stock mar-kets. After the FC’s plunge of market capitalization (see Figure 78) stocks could regain and eventually reached all time highs in 2014-2015, expectable from funds balance sheets, also found in the OECD’s index quantification of main stock market trends (see Figure 77).

Figure 76 Equity Funds Asset Portfolio Time-line

Times of low interest yields on monetary assets (see Figure 34 and Figure 39) made stock prices climb (see Figure 77). Simultaneously, EMU resident equity funds had higher stock volumes in assets (see Figure 76), in line with current asset market theory and quantifiable.

One can discern: (1) inter-product and (2) intra-product market forces. Inter-product mar-ket forces seem to be high but not adjusting as quick as anticipated in the efficient marmar-ket hypothesis. It has been a long matter of debate if stock prices reflect market value in real-time or not. The slow adjustment of all MTC₁₆ derived inter-product effects reveals: not fully. Intra-financial product market forces on the other side are obviously not so much af-fected and equilibria form fast and in real-time, but are imperfect-information-hyper-sensitive, and as a result may overshoot (see also 4.3.8.6).

Taken together, stock prices do not only reflect a corporation’s market value but also i n-clude the relative market value of the ‘financial vehicle’ involved, affected by MP. How real-istic these ‘doubled demand and supply’ derived stock prices are, remains questionable.

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Figure 77 Euro Area Share Price Development as Portfolio Indicator

Figure 77 provides empirical evidence that links a country’s finance to its stock prices. The dynamic trends reveal that the first step in the monetary transmission of MTC16 and MTC3,4,6,9 is efficient. How much of this upstream cascade necessarily results in a down-stream effect on GDP and ‘jobs’ seems context-dependent. Previous research results mainly support a downstream-inefficiency view as investment was poorly responsive (4.3.8.3). In years of low interest rates, from 2003-2007 the stock prices had soared until the MOC rate upswinged unexpectedly by a total of two points until 2008 - weakening European stock markets. The recent ZNLB (2.4.5) has shifted the preference of portfolios much towards non-monetary assets, as MP actions mainly exalt here stock prices. The ECB’s 2013 an-nouncement (flat MRO plus QE) made a 40% stock market growth predictable (via 2).These aggregated trends on the stock exchange markets originate from in equity invested ‘ house-holds’, pension and insurance corporations (€9tn) and investment funds (ca. €3tn). Only MFI’s equity is constant over time (see Figure 78), as if it were a ‘tacit consent’.

Figure 78 Total Market Capitalization (TMC) Portfolio Trend

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The sum is the EMU’s market capitalization; ca. 50% of shares held by residents are deno m-inated in Euro. International Management has accelerated trade and a ‘Financial Global i-zation’ that has changed many markets, also the EU’s real and financial markets (Caprio 2013). Inter alia this has resulted in a stronger European corporate bond market in addition to the expanding G-bond market, known in the EU as ‘sovereign debt securities market’. Debt and bond securities have gained 266% since the introduction of the Euro in 1999 (see Figure 79) at the expense of cash securities that have lost in volume since the FC/EC. An inverse kinetic is found for shares and cash securities (green vs. blue, right).

Figure 79 EMU Monetary versus Equity Portfolio Trends

In consideration of Eonia, Euribor, and NDER developments for households and corpora-tions (Figure 33 and Figure 39), the natural portfolio shifts should be predictable. MTC16(+3)

is another channel with a normal upstream functionality and a low transmission down-stream into the real economy due to legal system based downdown-stream inefficiencies.

All of these trends reviewed provide a more realistic and comprehensive big picture and utility to better predict future investment, consumption, MFIs and financial forces that sus-tain directions of business evolution, private equity firms, overall financial stability, and future portfolio decision, which are all still the key to Corporate Finance and Management.

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5 Conclusion and Discussion

First and foremost this review reassures that a true understanding of the Euro area’s econ-omy absolutely necessitates a comprehensive empirically founded knowledge of its MS. As money is the basic core of an economy the economics can be better understood from re-search of its MS and MP. Sometimes it is even viewed negligible, but in fact it plays the most important macroeconomic role, also for all businesses. This research insight is not as prevalent as one might expect - due to the common preconception of an efficient MS that works in the background only to maintain prices, liquidity, cash supply, and lending. In fact, if the MS would be efficient, its role in the economy would be more regular and MP re-search would be less important. Thus, all misconceptions usually start with a ‘misbelieve in an efficient MS’. It is effective not efficient, as it enables high volumes for a minimal output.

The new hybrid strategy of this study thesis, to research and review the monetary devel-opments and transmission in the euro area, has proven to be suitable, as it allows to pro-vide an informative overview, all of a piece to unravel the big picture and what really mat-ters. Gaps of missing or to be updated research findings (with new data until 7-2015) were begun to be closed - including the lack of efficiency of the MS whose details still much es-capes our knowledge (Görgens et al. 2014; Lee & Crowley 2010; Haan & Berger 2010). For the first time in MP research a systematic assessment of all 16 MTC was given here in one review and new core routines for data integration and research are proposed. The hybrid strategy was successful in uncovering major coherencies that were clearly forgotten by MP research - maybe due to the rigid formats of scientific publishing - including today’s censo r-ship of peer-reviewing. Thus, the hybrid research strategy is recommendable for future review approaches also in other fields of research. Old research standards, including ‘scie n-tific journals’ need to be replaced by open science with free access (to publish and to access publications) and more flexible and transparent formats and structures (David 2004).

Subtopic-specific conclusions were already given in the respective chapters about MP and MTC research results, to which is referred here for all specific interpretations (see Content).

An integrated and summarizing overview of all 16 MTC channels is given with a clear-cut recommendation toward MS reform to benefit EMU businesses, investment, employment and GDP growth. Future MP research should follow the strategy of this research approach to relentlessly get to the bottom of the monetary transmission efficiency to better

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stand the game-theoretical dilemma of the current MS, which is naturally hampered by the complexity and MFI-CF-opacity to protect a true private money-creation business model.

All published MP models of today are general and preliminary (2.4.2), and hence also very incomplete. A MTC1-16 based empirical, adjustable and extendable, model is provided here that also provides an overview of main findings of all chapters (6.1 Figure S18). It is a sum-marizing and conclusive weighting chimera-model based on a VAR/DC/ISLM-ADAS derived parameters and standard probability Markov-Chain-Matrix models. This prototype model further substantiates ‘oscillatory transmission’ (amplitude and frequency effect on MTCs) of a MP decisions over time. It shall also serve as a final informative overview of this study.

Although semi-quantification remains relative and preliminary as MP-efficiency models are still in unchartered waters it clearly corroborates a big lack of efficiency in the MS.

Put simple: newly created money can be channeled out of the Eurosystem’s MTCs via MFI

‘book keeping entry and accounting methods’ (Werner 2014). Money creation is not limited by the money multiplier as money can be recycled into PP by MFI while keeping the overall debt level (and their balance sheets) even beneficial for MFIs (=DT), which causes FRI.

Albeit hard to quantify, due to the dynamical nature of cash flows, ‘there can be no scien-tific doubt’ about this high level of MTC-inefficiency caused by fractional reserve banking.

The related MTC-loss is the reason for lower investment, higher unemployment rates, less GDP growth rates, more debt, and deep disincentives for ‘economic evolution’: economical-ly acting banks of firms are fundamentaleconomical-ly disadvantaged against illegitimate leverages.

Hence, first of all, the Eurosystem has to be evaluated to answer the questions: How well did the ECB strategy achieve a ‘monetary fit’ with the real economy? (see Table 3 (Sperber

& Sprink 1990)), but also (I) how well were MP options taken with respect to the ECB’s scope, and (II) how well is the EMU’s MS functioning and permitting suitable MP options?

5.1 Evaluation of the ECB’s MP: Towards a Stewardship of the Eurosystem