Excellent- an instant classic!

Modern Monetary Theory—A Primer on the Operational Realities of the Monetary System

By Scott Fulwiller

Europe Loan Growth Accelerates as Economy Recovers

By Christian Vits

Aug. 26 (Bloomberg) — Loans to households and companies in Europe grew at the fastest pace in 13 months in July after the economic recovery gathered steam.

Loans to the private sector rose 0.9 percent from a year earlier after growing an annual 0.5 percent in June, the European Central Bank in Frankfurt said today. That’s the strongest increase since June 2009. M3 money supply, which the ECB uses as a gauge of future inflation, increased an annual 0.2 percent in July, the same rate recorded in the previous month.

Strengthening global demand helped Europe’s economy expand 1 percent in the second quarter, the fastest pace in four years.

Economic growth may slow as governments reduce spending to tackle bloated budget deficits and the global recovery shows signs of losing momentum. Orders for durable goods in the U.S.

increased less than forecast in July, a sign one of the few remaining bright spots in the economy is cooling, while China’s industrial output rose the least in 11 months.

This is what the Fed calls the ‘hand off’ with private sector demand increasing via credit expansion as growth causes public sector deficits to fall.

Growth can go on for many years until the public sector deficits get too small to provide the income and financial equity needed to support the increasing private sector debt needed to sustain GDP growth.

Much of Europe got to higher levels of govt deficit spending than the US, before market forces triggered the funding crisis. The ECB has now stepped in to facilitate funding and at the same time implement the widely advertised austerity measures.

With modest growth deficits will start trending down on their own, as revenues increase and transfer payments (including interest payments) moderate, as private sector credit expansion replaces public sector debt as described above.

>   
>   (email exchange)
>   
>   On Tue, Aug 24, 2010 at 8:32 AM, Seth wrote:
>   
>   stocks look bad
>   looks like another panic
>   

It doesn’t look good technically.

Must be coming out of europe with gold up/euro down dynamic, etc.

Insiders there must be bailing.

Maybe they know something we don’t, or maybe they are wrong.

History is no help as in the past it’s been both.

Austerity is trimming growth there a bit around the edges, but deficits remain reasonably high, so GDP’s are probably at least muddling through, with overall growth probably positive.

The ECB keeps the short term funding channels open for the member nations, but that may not be fully appreciated yet.

On a mark to market basis bank capital is probably below requirements, and they may not realize that doesn’t have to matter to the real economy for as long as the ECB continues to fund them.

Lower crude oil prices support consumption of other things. With US crude oil product consumption up and Saudi output rising, demand must be ok. Maybe Saudis are worried and want lower prices to help world growth as well. Hard to ever say what they are actually up to. They may see the Iraqi production coming on stream and are trying to engineer an increase in demand. Again, no way to tell what they are up to.

The lower 10 year rates reflects expectations of ‘low for longer’ from the Fed due to high unemployment and falling rates of inflation as measured by the Fed. And the possibility of more QE that could flatten the curve further.

There is also the notion that there’s nothing left that the Fed can do of any consequence regarding aggregate demand, and Congress thinks it’s run out of money, which means flying without a net. That increases the weight of the downside in the balance of risks.

If markets and Congress knew that fiscal policy had no nominal limit and deficit spending was not dependent on being able to borrow from the likes of China to be paid by our grandchildren, the balance of risks would be viewed very differently. But they don’t know that.

With the elections coming and California reverting to vouchers again, the time is right for my per capita revenue sharing. But it’s not even a consideration.

Q3 and Q4 GDP estimates are looking more like 1.5%, and Q2 looks to be revised down toward 1% Friday. Not a double dip but no drop in unemployment either as productivity might be at least that high. That’s worse politically than it is for equities, and adds support for a ’second stimulus’ type of reaction. But that’s way down the road. More likely it causes most of the expiring tax cuts to be extended.

Thursday’s claims can make a big difference as well. The jump to 500,000 last week added an element of fear internationally.

Also, in thin summer markets technicals often cause exaggerated moves. Volume is very low, and a given size buying or selling causes larger moves to find someone willing to take the other side, and momentum type traders can easily overwhelm investors.

Still feels like the weakness is coming out of events in the euro zone,
as evidenced by the euro going down as gold goes up phenomena re emerging

It’s all being held together by the ECB buying national govt debt in the secondary market.

The question I’ve seen, is how long can the ECB keep doing this/what are the limits?

The short answer is there are no nominal limits, just political limits.

And the political limit is tolerance of inflation, and inflation control is their single mandate.

They don’t want deflation or inflation.

They are buying national govt debt to prevent a euro zone wide deflationary collapse.

So how much can they buy before it’s all inflationary?

Inflation comes from spending.

Traditionally, knowing the ECB is buying your debt and that you can’t default opened the door to moral hazard issues

A nation being supported would expand spending as much as possible.

But the ECB is first imposing ‘terms and conditions’ to prevent that before buying the national govt bonds.

So not only is (deficit) spending not being expanded, it is being cut back.

And, in any case, the euro zone national govts are complying with ECB demands, directly or indirectly.

So if it doesn’t work, it’s up to the ECB to implement alternative strategies.

It would make no sense for the ECB to cut off funding because an ECB directed policy fails.

With the ECB directly or indirectly in control of member nation fiscal policy,

And with no one increasing their spending in any material way,

I don’t see a demand pull inflation possible as a function of ECB securities buying, no matter how large.

And with deficits over there already high enough for at least modest growth, which seems to be materializing,
it will be a while before fiscal gets too tight for modestly positive growth.

China shifting towards euro buying might indicate they want to beef up exports to the eurozone.

And China probably knows with the credit issues in Europe the last thing the euro zone can do is discourage them from buying euro national govt debt.

Wouldn’t even surprise me if China cut a deal with the ECB to backstop any credit issues before buying as well.

If so, it’s a nominal wealth shift from the euro zone to China as the euro zone national govts pay them a risk premium and then the ECB guarantees the debt.

China is even buying yen, highlighted below, indicating they may be trying to slow imports from Japan and maybe even increase exports to Japan as well.

And Japan my already be quietly buying $US financial assets as indicated by their rising holdings of US Treasury securities.

Looks like a floating exchange rate version of the gold standard ‘beggar they neighbor’ trade wars may be brewing.

This would be an enormous benefit for the US if we knew how to use fiscal policy to sustain domestic demand at full employment levels.

China Favors Euro to Dollar as Bernanke Shifts Course

By Candice Zachariahs and Ron Harui

August 16 (Bloomberg) — China, whose $2.45 trillion in foreign-exchange reserves are the world’s largest, is turning bullish on Europe and Japan at the expense of the U.S.

The nation has been buying “quite a lot” of European bonds, said Yu Yongding, a former adviser to the People’s Bank of China who was part of a foreign-policy advisory committee that visited France, Spain and Germany from June 20 to July 2. Japan’s Ministry of Finance said Aug. 9 that China bought 1.73 trillion yen ($20.1 billion) more Japanese debt than it sold in the first half of 2010, the fastest pace of purchases in at least five years.

“Diversification should be a basic principle,” Yu said in an interview, adding a “top-level Chinese central banker” told him to convey to European policy makers China’s confidence in the region’s economy and currency. “We didn’t sell any European bonds or assets, instead we bought quite a lot.”

China’s position may make it harder for the greenback to rebound after falling as much as 10 percent from this year’s peak in June as measured by the trade-weighted Dollar Index. The nation cut its holdings of U.S. government debt by $72.2 billion, or 7.7 percent, through May from last year’s record of $939.9 billion in July 2009, according to the Treasury Department, which releases new data today.

U.S. Concerns

Concern the U.S. economy is faltering was underscored by the Federal Reserve on Aug. 10. Chairman Ben S. Bernanke said the central bank will reinvest principal payments on its mortgage holdings into Treasury notes to prevent money from being drained out of the financial system, its first expansion of measures to spur growth in more than a year.

“The pace of economic recovery is likely to be more modest in the near term than had been anticipated,” the Federal Open Market Committee said in a statement after meeting in Washington. “The Committee will keep constant the Federal Reserve’s holdings of securities at their current level.”

Asian central banks holding some 60 percent of the world’s foreign-exchange reserves are turning away from the dollar. Concerned about weakening U.S. growth and the Treasury’s record borrowing, they are switching toward euro assets to safeguard reserves, driving gains in the 16-nation currency. South Korea, Malaysia and India reduced their holdings of Treasuries, U.S. government data show.

Cutting Treasuries

The allocations to dollars in official foreign-exchange reserves declined in the first three months of the year, to 61.5 percent from 62.2 percent in the final quarter of 2009, the International Monetary Fund said June 30.

The yen’s share was 3.1 percent, up from 3 percent, The euro’s was 27.2 percent, little changed from 27.3 percent, even after the currency tumbled 5.7 percent versus the dollar during the first quarter on speculation that nations including Greece will struggle to rein in their budget deficits.

“Short of concerns of a default, the investor community in terms of big reserve managers will probably be forced to invest in the euro zone,” said Dwyfor Evans, a strategist in Hong Kong at State Street Global Markets LLC, part of State Street Corp. which has $19 trillion under custody and $1.8 trillion under management. “They can’t be putting all of their eggs in one basket, which is U.S. Treasuries.”

Dollar Index

The Dollar Index’s 5.2 percent drop in July, the biggest decline in 14 months, failed to dissuade most foreign-exchange forecasters from predicting the greenback will strengthen against the euro and yen by December.

The dollar traded at $1.2817 per euro as of 7:13 a.m. in New York from $1.2754 last week, when it rose 4.1 percent. The greenback was at 85.60 yen after falling to 84.73 yen on Aug. 11, the weakest since July 1995.

The U.S. currency will climb to $1.23 per euro by Dec. 31 and to 92 yen, based on median estimates of strategists and economists in Bloomberg surveys. Economists forecast U.S. growth will be 3 percent this year, compared with 1.2 percent for the region sharing the euro and 3.4 percent for Japan.

“There’s no sign of panic or urgency from the Fed and that supports our view that this is a temporary soft patch and the U.S. economy will fight its way through,” said Gareth Berry, a Singapore-based currency strategist at UBS AG, the world’s second-largest foreign-exchange trader. UBS forecasts the dollar will rise to $1.15 per euro and 95 yen in three months.

Slower Growth

Japan’s economy expanded at the slowest pace in three quarters, missing the estimates of all economists polled, the Cabinet Office said today in Tokyo. Gross domestic product rose an annualized 0.4 percent in the three months ended June 30, compared with the median estimate in a Bloomberg survey for annual growth of 2.3 percent.

Slowing purchases of Treasuries by Asian nations haven’t hindered President Barack Obama’s ability to finance a projected record budget deficit of $1.6 trillion in the year ending Sept. 30. Investor demand for the safest investments compressed yields on benchmark 10-year Treasury notes to a 16-month low of 2.65 percent today, even after the U.S.’s publicly traded debt swelled to $8.18 trillion in July.

U.S. mutual funds, households and banks in May boosted their share of America’s debt to 50.2 percent, the first time domestic investors owned more Treasuries than foreign holders since the start of the financial crisis in August 2007.

‘Concrete Steps’

Chinese Premier Wen Jiabao urged the U.S. in March to take “concrete steps” to reassure investors about the safety of dollar assets. The nation, which is the largest overseas holder of Treasuries, trimmed its stockpile of U.S. debt to $867.7 billion in May, from $900.2 billion in April and a record $939.9 billion in July 2009.

Increases to its holdings made between June 2008 and June 2009 amid the global financial crisis were mostly in short-term securities, signaling a “lack of confidence” in the U.S. ability to reduce its debt, UBS said in a research note Aug. 9.

“China has confidence in Europe’s economy, in the euro, and the euro area,” Yu said. A member of the state-backed Chinese Academy of Social Sciences, Yu was selected by the official China Daily to question Treasury secretary Timothy F. Geithner during his June 2009 visit to Beijing about risks the U.S.’s budget deficit will undermine the value of its debt.

Chinese Purchases

Chinese purchases of Europe’s bonds come in the wake of measures taken by European policy makers to allay concern the sovereign-debt crisis will threaten the single-currency union. In May, they announced a loan package worth as much as 750 billion euros ($956 billion) to backstop euro-area governments.

That month, foreign investors were net buyers of euro-zone debt as the 16-nation currency plummeted by the most since January 2009. Foreigners purchased 37.4 billion euros of bonds and notes after buying 49.7 billion euros in April, the latest data from the European Central Bank show.

China’s concern is mirrored by neighboring central banks that are building up foreign-exchange reserves as they sell local currencies to maintain the competiveness of exporters, according to Faros Trading LLC, which conducts currency transactions on behalf of hedge funds and institutional clients.

Indonesia’s central bank and Thailand’s prime minister said in the past month they are watching the performance of their nation’s currencies amid speculation gains will curb exports. Taiwan’s dollar has depreciated in the final minutes of trading on most days in the past four months as policy makers bought dollars, according to traders familiar with the central bank’s operations who declined to be identified. Exports account for about two-thirds of Taiwan’s gross domestic product.

‘Rapidly Diversifying’

“Asian central banks, other than China, don’t want to be caught holding all of the dollars when China is rapidly diversifying,” said Brad Bechtel, a Connecticut-based managing director with Faros Trading. “When sentiment shifts and people start getting very bearish on the euro again, beware central banks might be aggressively buying euros on the other side.”

The yen has climbed 8.4 percent against the dollar this year. China bought a net 456.4 billion yen of Japanese debt in June, after purchasing 735.2 billion yen in May, which was the largest in records dating from 2005, according to Japan’s Ministry of Finance data.

“China’s policy of steady and relatively rapid accumulation of foreign-exchange reserves means they have to be invested somewhere,” said Greg Gibbs, a currency strategist at Royal Bank of Scotland Group Plc in Sydney. “It is easy to imagine that given the low yields in the U.S. and the debt crisis in Europe, China is now willing to invest more of these reserves in the yen.”

Link:

Valance Chart Review (PDF)

I’ve been on the road, and not as close to things as usual, so from what I’ve seen and heard:

Looking at the market prices I’d guess yesterday’s sell off was a euro zone credit response.

The euro dropped a quick 3% and gold went up enough to be up even in dollars.

When Europeans get scared they often run to gold and dollars.

The ECB reportedly bought some Irish paper, indicating concern and also showing they will continue to support national govt funding.

Liquidity is not what it used to be. Sudden violent moves can just as easily be due to relatively small buyers and sellers and not any kind of fundamental shift. It can all reverse just as quickly as it sold off.

I’d key off the euro. It was up a tad last I checked, and stocks were stabilizing.

The fact that q2 earnings were very strong even as Q2 GDP was not so strong is a good sign for stocks.

Congress has extended unemployment benefits, approved 26 billion for the states, and is toying with extending the tax cuts set to expire, all indicating there will not be any serious deficit reduction interference for at least the rest of the year.

Last I checked Federal revenues had bottomed and were starting to rise indicating an underlying positive tone to the economy.

8%+ continuing Federal deficits are a very large tailwind that I expect to keep GDP in positive territory.

Weekly claims are on the high side, but not at double dip levels and continuing claims continue to fall. And the combo of hours worked and new jobs shows ongoing improvement.

Lack of consumer credit expansion (borrow to buy) keeps it all moderate, though poised for expansion as debt to income ratios have continued to fall due to the federal deficits.

Federal deficits have added to net financial assets and incomes of households, allowing them to spend from income and also add to savings, as indicated by firm final demand in the Q2 GDP revisions.

Lastly, Q3 has shown declines in a variety of markets over the last few years making rear view mirror traders more than cautious.

Hate to criticize someone proposing a payroll tax holiday- darn that Lerner’s law!

A Big Bang for Greece

There is a way out of the debt trap for Athens.

By Stece H. Hanke

June 30 (WSJ) — How did Greece get into the death spiral that it’s in? Unfunded entitlements. In other words, promise somebody something, don’t come up with the financing for it, and pretty soon you find yourself in a fiscal/debt crisis.

Yes, happens to those who are not the issuer of their currency all the time, including those with fixed fx arrangements. EU members, US States, corporations, households, Russia when fixed to the dollar, Mexico when fixed to the dollar, etc.

But never with issuers of the currency. They can always make payments as desired.

This is where Greece ended up, and in February, the Greek government called in some outside advisers (Joseph Stiglitz for one), and the blame game began. Prime Minister Papandreou, who is also president of Socialist International, started blaming everyone. First, it was the speculators. Then he went on a tear against his own colleagues in the European Union. The Germans really got whacked­ according to Mr. Papandreou, they were a big cause of Greece’s troubles.

Never would have happened under the drachma. Just would have been the usual inflation and currency depreciation.

But Greece is a user of the euro, not the issuer like the ECB is.

Ironically, after blaming outsiders for all their problems, the Greeks have called in the foreign doctors. In this case it isn’t just the IMF, but also the EU politicians and bureaucrats who are involved. But this may ultimately be a case in which the doctors kill the patient.

The problem ended for Greece and the entire eu in general only after the ECB agreed to ‘write the check’ and started buying greek bonds.

There was no other way.

To address the moral hazard issue that comes with ECB support, the ECB insisted on the ‘terms and conditions’ to contain inflation possibilities

They haven’t started with what they should be doing, but with a standard IMF-type austerity program. The government has promised to cut public expenditures. It has also raised taxes. Unlike neighboring Bulgaria, which did exactly the right thing by refusing to increase its VAT, Greece has increased its VAT twice since the crisis.

What should Greece have done? It should have started with a Big Bang, doing a number of things simultaneously a la New Zealand. In 1984, New Zealand elected a Labor government after Robert Muldoon’s National Party governments had made a complete mess of the economy. The Muldoon governments introduced, over the course of almost a decade, a socialist-style system in New Zealand. Labor, under finance minister Roger Douglas, introduced structural reforms centered on deregulation and competitiveness. As a consequence, New Zealand had a massive economic revolution after the ‘84 election. Greece should adopt a New Zealand-type Big Bang.

The NZ gov was the issuer of its own currency and therefore didn’t face the solvency problem Greece did. otherwise it would have been an entirely different story.

As part of its Big Bang, Greece should have begun by rescheduling its debt. But it also should have implemented a supply-side fiscal consolidation. That means cutting government expenditures, but also changing the tax regime.

Without the ECB writing the check, that would have resulted in a systemic collapse of the euro member national govts and the payments system in general.

With the ECB writing the check there are other options.

Right now, Greece has very onerous payroll taxes that are paid by employers and, ultimately, labor. As part of a Big Bang, Greece should eliminate the employer contribution to payroll taxes, which is currently 28% of wages (employees pay a further 16% rate directly).

With funding entirely dependent on the good will of the ECB, those decisions are up to the ECB, not Greece. If they cross the ECB they get cut off and again face default.

At the same time, Greece should make its VAT rates uniform. Right now, there are three VAT rates in Greece. This is typical in Europe. You have the regular VAT, a VAT that is reduced by 50% for other categories, and, finally, a super-reduced VAT. I would eliminate the reduced and super-reduced rates, and just have one, uniform rate for the VAT one set below the current top VAT rate of 23%.

If Greece did those two things, it would end up generating more revenue than it is generating right now. Even when based on a static, simple-minded analysis, that would put Greece ahead of the revenue game.

At the macro level for the EU it’s about the right fiscal balance needed to sustain growth and employment, which is probably a deficit higher than the growth rate. But at the micro level it’s about credit worthiness which means a deficit lower than the growth rate. So the members need to be tighter than the union needs to be. This requires a central govt/ECB that runs the needed deficits to make it all work efficiently. Much like the US states balance and the fed govt runs the deficits.

But more importantly, it would also substantially reduce its economy’s labor costs overnight. Employers’ social security contributions are about 7.8% of GDP. Eliminating the employer contribution would yield about a 22% reduction in the overall Greek wage bill as a percentage of GDP. This would make the Greek economy more competitive­ without the currency devaluation that some commentators claim is necessary. These changes would also, obviously, reduce consumption, increase savings, and reduce the level of debt in the country.

Allow me to make a comment about devaluation. There are some people who are wringing their hands and saying, “Well, the problem with Greece is that it put itself into a euro straitjacket and it can’t devalue the drachma anymore. So, Greece is in a trap. There’s nothing it can do!”

Yes, but note devaluing was never a policy tool. It was the consequence of policy. Today the consequence of the same policy is default rather than currency depreciation.

But there is something the Greeks can do. They can reduce the economy’s total labor cost by 22%, simply by eliminating the employer contribution to payroll taxes. To see what the size of a devaluation would have to be to generate a positive competitiveness shock of this magnitude, let’s assume that 50% of a devaluation would be passed through to the economy in the form of increased inflation­ reasonable assumption about a small, open economy like Greece’s.

In this case, Greece would have to have a 44% devaluation to be equivalent, in terms of competitiveness, to the positive shock that would accompany the elimination of the employer contribution to payroll taxes.

So, with the elimination of the employer contribution to the payroll tax, Greece would enhance its competitiveness. The enhancement would be equal to roughly a 44% devaluation. Moreover, the supply-side generated competitiveness would not be accompanied by the inflation and widespread private-sector bankruptcy that a devaluation would provoke.

Needless to say, neither Greece nor its international partners are contemplating a voluntary debt restructuring,

That would also require a restructuring of the banking system as the loss of capital would require some kind of adjustment as well.

let alone a supply-side Big Bang, which makes it more likely that Greece will remain stuck in a trap. But don’t let anyone tell you there’s nothing Greece could do. It’s not too late to change course. What’s more, other countries in Europe that are facing down a possible debt crisis could likewise try a similar approach­reschedule debt, cut taxes on labor to improve competitiveness and spur job creation, while raising some consumption taxes to keep the revenue coming in. There is a way out of the Greek trap.

Mr. Hanke is a professor of applied economics at the Johns Hopkins University in Baltimore and a senior fellow at the Cato Institute in Washington, D.C. This article is adapted from remarks made at the Cato Institute’s Policy Forum, “Europe’s Economic Crisis and the Future of the Euro,” on May 11, 2010, Washington, D.C.

As previously discussed, the recovery looks real to me, firmly supported by very high public sector deficits, and the implied support of the ECB which continues to stand by to fund the banking system as well as to buy national govt debt in the secondary markets as needed.

Yes, there are downside risks from external shocks and from future fiscal consolidation, but there are also offsetting upside risks to forecasts as well.

EU Headlines:

European Loan Growth Accelerated in June as Economy Recovered

EU Tests Get Positive Response From Finance Firms, BofA Says

Basel Committee Agrees New Bank Capital Rules

Germany Refuses to Sign Parts of New Basel Accord, WSJ Says

Germany warned of ‘big challenges’ ahead

German consumer confidence up strongly

Spanish Debt Costs Fall in First Auction Since Stress Tests

Asian players are a worry for eurozone

By Gillian Tett

July 14 (FT)

The saga behind next week’s stress test release is a case in point. During most of the past year, governments of countries such as Germany, Spain and France have resisted the idea of conducting US-style stress tests on their banks, in spite of repeated, entreaties from entities ranging from the International Monetary Fund to the Bank for International Settlements, and the US government.


However, after a meeting of G20 leaders in Busan last month, those same eurozone governments performed a U-turn, by finally agreeing to publish the results of such tests.


Some observers have blamed the volte-face on lobbying inside the senior echelons of the European Central Bank. Others point the finger to American pressure. In particular, Tim Geithner, the US Treasury secretary, had some strongly worded discussions with some of his eurozone counterparts in Busan, where he urged – if not lectured – them to adopt these tests.

However, Europeans who participated in the Busan meeting say it was actually comments from Asian officials that created a tipping point. In the days before and after that G20 gathering, eurozone officials met powerful Asian investment groups and government officials who expressed alarm about Europe’s financial woes. And while those officials did not plan to sell their existing stock of bonds, they specifically said they would reduce or halt future purchases of eurozone bonds unless something was done to allay the fears about Europe’s banks.

That, in turn, sparked a sudden change of heart among officials in places such as Germany and Spain. After all, as one European official notes, the last thing that any debt-laden European government wants now is a situation where it is tough to sell bonds. “It was the Asians that changed the mood, not anything Geithner said,” says one eurozone official.

This raises some fascinating short-term issues about how the bond markets might respond to the stress tests. It is impossible to track bond purchase patterns with any precision in a timely manner in Europe, since there is no central source of consolidated data.

However, bankers say there are signs that Asian investors are returning to buy eurozone bonds. This week, for example, China’s State Administration of Foreign Exchange bid for €1bn (£1.27bn, £835m) of Spanish bonds, helping to produce a very successful auction.

Yes, it’s a two edged sword.

Asian nations want to accumulate euro net financial assets to facilitate exports to the euro zone.

Before the crisis euro nations were concerned that the strong euro, partially due to Asian buying, was hurting euro zone exports

However, as the crisis developed, euro nations got to the point where they were concerned enough about national govt solvency and the precipitous fall of the euro (which was in some ways welcomed by exporters but worrying with regards to a potential inflationary collapse) to agree to measures to support their national govt debt sales which also meant a stronger euro.

So now the pendulum is swinging the other way. Solvency issues have been sufficiently resolved by the ECB to avert default, but at the ‘cost’ of a resumption Asian buying designed to strengthen the euro to support Asian exports to the euro zone.

As before the crisis, however, the euro zone has no tools to keep a lid on the euro (apart from re introducing the solvency issue to scare away buyers, which makes no sense), as buying dollars and other fx is counter to their ideology of having the euro be the world’s reserve currency.

So the same forces remain in place that drove the euro to the 150-160 range, which kept net exports from climbing.

The export driven model is problematic enough without adding in the additionally problematic idiosyncratic financial structure of the euro zone.

As for the stress tests, as long as the ECB is funding bank liabilities and buying national govt debt banks and the national govts can continue to fund themselves with or without Asian buying.

I’d have to say at this point in time the euro zone hasn’t gotten that far in their understanding of their monetary system or they probably would not be making concessions to outside forces.

I got a nice mention in a CNBC article today:

Why Portugal Downgrade Didn’t Slam Stocks

By Antonia Oprita

July 13 (CNBC) — Investors do not see Portugal’s rating downgrade by Moody’s as an event that will shake the markets, but it confirms the fact that the outlook for some economies in the euro zone is still cloudy, economists and market analysts told CNBC Tuesday.

Moody’s slashed Portugal’s credit rating by two notches to A1, citing a deterioration of the country’s debt ratios and weak growth prospects.

Portugal’s debt-to-GDP and debt-to-revenue ratios have risen rapidly in the past two years, Anthony Thomas, vice president and senior analyst in Moody’s Sovereign Risk Group, said in a statement.

The euro fell after the announcement and the spread between Portuguese and German 10-year government bonds widened by 4 basis points to 290 points.

“The bond markets response hasn’t been dramatic,” Martin van Vliet, euro-zone economist at ING Bank, told CNBC.com.

The downgrade came a little before a Greek auction to sell 6-month T-bills, the first since a bailout package agreed by the European Union and the International Monetary Fund in May.

Greece sold 1.625 billion euros ($2.03 billion) of 6-month instruments at a yield of 4.65 percent, up from 4.55 percent in a similar auction on April 13, according to Reuters.

“The markets will probably reason that the risk of default in six months is small,” van Vliet said.

Growth Is Key

Economic growth in Europe’s peripheral countries will be crucial to bring back investor confidence but more and more analysts fear a slowdown in the second quarter everywhere in the world.

“The outlook for Portugal is not particularly optimistic,” David Tinsley, economist at National Bank of Australia, said. “It is in a very slow growth trajectory and therefore all its fiscal retrenchment has got to come from public spending cuts.”

Over the longer term, investors are still afraid of the risk of default and European Central Bank President Jean-Claude Trichet hinted that the need to intervene by buying bonds is not that strong any longer, according to van Vliet.

“My guess is that they will have to continue buying bonds,” he said. “It all depends on whether the economy will start growing in Greece.”

The risk of default by one of the southern European countries was the main fear in the markets earlier this year, when ratings downgrades sparked massive selloffs in stocks as well as bonds and investors were taking refuge in US Treasurys, gold and cash.

“The process of credit downgrades reinforcing confidence erosion, I think that’s a bit over,” van Vliet said.

Default Risk Is Gone

Investors will slowly realize that the risk of default by European nations on their debt is gone, and they will push up stock prices and the euro, according to economist Warren Mosler, founder and principal of broker/dealer AVM.

In June, Mosler told CNBC.com the euro was likely to rise to between $1.50 and $1.60 because of the austerity measures in Europe.

He reaffirmed his stance, saying that there had been a “mad rush for the exits” by Europeans, who bought dollars and gold, pushing the euro down, when the default risk was high.

But the ECB’s decision to buy Greek bonds showed the bank was ready to spend money to defend countries in the euro zone and “there is no limit to what the ECB can spend,” Mosler told CNBC.com.

The ECB has put itself in a top position by doing this, as it can impose terms and conditions on any country that sells it its bonds, he explained.

“What that did is it shifted power from fiscal policy to the ECB,” Mosler said. “I would say they will not buy these bonds unless they can impose their terms and conditions.”

“It allows them to cut out one member selectively, without the whole system collapsing,” he said.

This latest announcement of the purchase of Irish bonds shows the ECB is continuing its policy of buying national govt bonds to facilitate solvency:

EU Headlines:
Europe’s bankers in talks over bail-out fund

Support for European spending cuts strong

European Bank’s Economist Is Optimistic on Sovereign Debt, but Critics Are Wary

EU Ministers Pressured to Give More Stress Test Data

ECB’s Bini Smaghi Favors Lower Deficit Limit for Stability Pact

ECB Buys 8 Billion Euros of Irish Bonds, Sunday Tribune Says

ECB Buys 8 Billion Euros of Irish Bonds, Sunday Tribune Says

July 11 (Bloomberg) — The European Central Bank bought about 8 billion euros ($10.1 billion) of Irish government bonds in the last seven weeks, the Sunday Tribune said, without saying where it got the information. The purchases account for as much as 10 percent of outstanding Irish bonds, the Dublin-based newspaper said.

Looks like my story is unfolding. OK Spanish auction as well. Assuming equity markets were down say 20% from the highs pricing in half the risk of default, they should adjust upward by most of that as default risk fades:

The European Central Bank bought €4bn ($5bn) in eurozone bonds last week, the same as in the previous two weeks, indicating it had fallen into a pattern of low-level intervention in sovereign debt markets, the FT reports.

Euro Central Banks Step Up Bond Buying, Traders Say

By Paul Dobson

June 29 (Bloomberg) — Euro-region central banks stepped up purchases of Greek, Portuguese and Irish government securities today, traders said, deepening efforts to support the region’s bond market in the wake of the sovereign-debt crisis.

The purchases focused on maturities of five years and below, with some buying interest also shown for longer-maturity Greek bonds, said the traders, who declined to be identified because the transactions are confidential. The extra yield, or spread, investors demand to hold the nations’ securities instead of benchmark German debt narrowed.

The European Central Bank took the unprecedented decision to start buying government bonds last month to help the European Union contain the Greek debt crisis. The ECB said yesterday it bought 4 billion euros ($5 billion) of bonds last week, taking the total purchases as of June 25 to 55 billion euros. Greek debt spreads had been widening, approaching their levels before the EU rescue was announced in early May, amid speculation funds that track bond indexes were selling the debt.

Central banks “are more active than they have been of late,” said Huw Worthington, a fixed-income strategist at Barclays Capital in London. “There has been a lot of volatility in a lot of the spreads, and some concerns of selling ahead of the month end.”

Greek two-year notes rose, sending the yield down 41 basis points to 10.19 percent as of 3:43 p.m. in London. The yield spread with German two-year notes fell 39 basis points to 1001 basis points. The yield on 10-year Greek bonds fell 41 basis points to 10.57 percent.

Greek securities will leave indexes managed by Citigroup Inc., Barclays Plc and the Markit iBoxx index at the end of this month after they were downgraded to junk by Moody’s Investors Service, potentially triggering sales by managers in so-called passive funds.

The Irish two-year bond yield fell 11 basis points to 2.88 percent and equivalent-maturity Portuguese yields dropped nine basis points to 3.61 percent.

ECB purchases of govt bonds for last week amounted to EUR 4 billion,
matching previous week and bringing total to EUR 55 billion:

Week     Purchases    Total
1           16.5            16.5
2           10.0            26.5
3           8.5              35.0
4           5.5              40.5
5           6.5              47.0
6           4.0              51.0
7           4.0              55.0

That’s a lot of greek bonds, presumably the ECB is buying enough to support rates sufficiently so they can refi themselves.

If I’m right about the ECB having moved to support the debt of the national governments as well as the banking system, look for a blow out equity rally as markets come to understand this new policy means the national government solvency issues are over.

A muddle through economy is sufficient to drive an equity rally for a market that’s pricing in a relatively high probability of default risk.

Still looks like the strategy for Europe could be functionally very close to my proposal, and fiscally sustainable if they continue on the current path.

This is just inference on my part- I have no information other than what I’ve read online.

The ‘distributions’ the ECB will make will be via buying enough national govt debt in the secondary markets to keep the national govs solvent and able to fund their deficits, at least in the short term markets.

If they determine any member nation is not complying to their liking, they will start threatening to stop buying their debt, thereby isolating them from the ECB credit umbrella, while allowing the remaining nations to remain solvent.

ECB spending on anything is not (operationally) revenue constrained as the member nations are, so this policy is nominally sustainable.

The austerity measures will result in lower growth, and maybe even negative growth, but the solvency issue is gone as long as this policy is followed.

With currency strength and inflation ultimately a function of fiscal balance, the fundamental forces in place that drove the euro to 1.60 vs the dollar remain in place, while the mechanism to remove the default risk that drove the portfolio shifts that weakened the euro is in place.

While restructuring risk remains, it need not be forced by solvency risk. So restructuring need not happen.

Power has shifted to the ECB, presumably under substantial influence of the national govt finance ministers, as the ECB directly or indirectly moves to fund the entire banking system and national govt. deficits.

This is an institutional structure that is fully sustainable financially, with the economic outcome a function the size of the national govt. deficits they allow.

The conflict will remain the money interests in Europe who put currency strength as a priority, vs the exporters who favor currency weakness.

The consensus will be that unions and wages in general must be controlled.

Again, I do not know for sure that the ECB is actually moving in this direction.
They may not be.

Watch closely to see if the buying of national govt. securities remains sufficient to keep the national govts solvent.

(Feel free to distribute)

HEADLINES:

Europe Rebound Stalls in June on Market Strains, Eurocoin Shows
Barroso Says European Leaders Want to Keep Euro ‘Very Strong’
Schaeuble Says Europe Will Meet Deficit Targets, Corriere Says
Merkel faces test in vote for president
Berlin hints at move on pay deal ruling
Germany Trims 3rd-Quarter Debt Sales, Plans Bigger Cuts in 4th
Germany Faces Shortage of Skilled Workers in 2025, Study Says
French Economy Slowed to a Crawl in First Quarter of 2010
French Jobless Claims Increase as Companies Trim Workforces
Lagarde Says Pension Reform Is Priority, Sees AAA Rating Safe
Confindustria Raises Italian GDP Growth Forecast on Euro Drop
Spanish May Producer Prices Advance Most in 19 Months on Oil
Spain May Cut 426-Euro Unemployment Subsidy, Cinco Dias Reports
Greek optimistic on budget deficit reduction

ARTICLES:

Europe Rebound Stalls in June on Market Strains, Eurocoin Shows

(Bloomberg) The euro-area economic recovery stalled in June for a third month amid financial-market “strains.” The Eurocoin index measuring economic expansion in the 16 nations that share the single currency fell to 0.46 percent from 0.55 percent in May, the Center for Economic Policy Research and the Bank of Italy, which co-produce the index, said in a statement. “Recent strains in the financial markets have affected the performance of the indicator,” according to the statement. The index “has however been supported by the new improvement in foreign trade.” The index, which includes business and consumer confidence readings, industrial production, price figures and stock-market performance, aims to provide a real-time estimate of economic growth, according to the report.

Barroso Says European Leaders Want to Keep Euro ‘Very Strong’

June 25 (Bloomberg) — European Commission President Jose Barroso said the region’s leaders are determined to keep the euro a “very strong” currency.

“I have no doubts of the absolute determination of European Union leaders and European Union institutions to keep the euro as a very strong and stable currency,” Barroso said in an interview with Bloomberg Television in Toronto, where he is attending a meeting of leaders from Group of 20 countries.

Against the U.S. dollar, the euro has fallen 19 percent since its Nov. 25 high, trading yesterday at $1.2279 after reaching a four-year low of $1.1877 on June 7.

The 16-nation currency’s “real effective exchange rate has lost close to 10 percent” since its peak in October, the European Commission, the EU executive, said yesterday in its quarterly assessment of the euro-region economy.

The continent’s economic “fundamentals” are good, and Europe’s debt and deficits are smaller than some of its “main partners,” Barroso said, adding investors have been reassured by an almost $1 trillion plan by the euro nations and the International Monetary Fund to backstop the sovereign debt of the region’s weakest members.

It’s “a very important message of confidence that is being conveyed to markets as well,” Barroso said.

Barroso also said that China’s plan to provide more currency flexibility was a “move in the right direction” that increases confidence in the global economy.

Earlier yesterday, Barroso said that exit strategies from fiscal stimulus programs should be gradual, differentiated and “growth-friendly.”

Schaeuble Says Europe Will Meet Deficit Targets, Corriere Says

June 25 (Bloomberg) — German Finance Minister Wolfgang Schaeuble said he has “no doubt” that European governments will hold to their commitments to cut public deficits, Corriere della Sera reported, citing an interview.

“Too-high deficits have to be responsibly reduced,”

Corriere quoted Schaeuble as saying. “We have a shared agreement, and I have no doubt that all will abide by their commitments.”

Merkel faces test in vote for president

(FT) The presidential election – in a specially constituted federal assembly – represents the biggest challenge for Angela Merkel since she formed a government in October combining her own Christian Democratic Union with the liberal Free Democratic party. The combined popularity of the coalition parties has since dropped from 48.4 per cent to 35 per cent, according to a poll published by Stern magazine and the RTL television network. The proportion of voters saying they would vote again for Ms Merkel as chancellor has also dropped to just 39 per cent, her lowest rating for more than three years, according to a Forsa institute poll. Political scientists believe that if Christian Wulff, Ms Merkel’s candidate for the presidency, were to lose the vote on Wednesday to Joachim Gauck, the non-party candidate supported by the SPD and Greens, it could force the resignation of both the chancellor and her government.

Berlin hints at move on pay deal ruling

(FT) The German government on Thursday signalled it was considering legislation to quell protests from both company chiefs and worker representatives over a court ruling that threatens the way they agree wage deals. Judges in Erfurt, eastern Germany, on Wednesday ended a 50-year-old practice of extending in-house wage deals made between an employer and its biggest union to cover all workers in the company doing similar jobs. The judges agreed with a doctor at a hospital in Mannheim who had demanded he be paid according to the national pay deal of the doctors’ union, not the in-house deal agreed by services union Verdi. They said in their verdict that established wage-bargaining practices contravened the right of citizens freely to form alliances. There was no “basic principle” forcing a company “to adopt a uniform wage deal”, they declared.

Germany Trims 3rd-Quarter Debt Sales, Plans Bigger Cuts in 4th

(Bloomberg) Germany will sell 77 billion euros ($94.5 billion) of bonds and bills in the third quarter, 2 billion euros less than forecast in December. A larger adjustment will come in the fourth quarter, assuming the economy stays steady, a finance ministry official said. Finance Minister Wolfgang Schaeuble has pledged to cut net new borrowing by the end of the year. A federal issuance calendar released in December said gross debt sales this year would be a record 343 billion euros ($421.5 billion). The third-quarter debt issuance includes 44 billion euros of bonds and 33 billion euros of bills. Schauble’s ministry said on June 22 that the so-called structural budget deficit will be 53.2 billion euros this year, 13.4 billion euros less than the 66.6 billion euros originally expected. It also said then that net new borrowing this year will be 15 billion euros below the 80.2 billion euros in the 2010 budget plan.

Germany Faces Shortage of Skilled Workers in 2025, Study Says

June 25 (Bloomberg) — Germany faces a shortage of skilled workers in 2025 as the population is shrinking, the Federal Labor Agency’s research institute said.

Due to demographic reasons the size of the German workforce will constantly decrease until 2025 while the number of employed in the services industry may rise by more than 1.5 million, the institute said in a study published yesterday.

By contrast, the number of employees in the manufacturing industry may fall by almost 1 million over the next 15 years, the study said.

German unemployment fell more than twice as much as economists forecast in May as exports from Europe’s biggest economy surged, bolstering the recovery. The number of people out of work declined a seasonally adjusted 45,000 to 3.25 million, the lowest since December 2008, the Labor Agency said June 1.

French Economy Slowed to a Crawl in First Quarter of 2010

Paris (dpa) — The French economy slowed alarmingly in the first quarter of 2010, with gross domestic product (GDP) expanding by only 0.1 per cent, the government’s statistics office Insee said Friday.

The primary reason for the poor result was a drop of 0.2 per cent in domestic demand, compared to an increase of 0.5 per cent in the last quarter of 2009, when GDP rose by 0.6 per cent.

This was the second bit of bad economic news for the government in less than 24 hours. Late Thursday, the Labour Ministry said that the rolls of unemployed had grown by some 22,600 in May, the largest rise in unemployment since the beginning of the year.

Some 2.7 million people were out of work at the end of May, an unemployment rate of 9.5 per cent.

French Jobless Claims Increase as Companies Trim Workforces

(Bloomberg) The number of jobseekers in France climbed in May as manufacturers trimmed payrolls in the wake of the country’s worst recession in more than half a century. The number of unemployed actively looking for work rose by 22,600 last month, an increase of 0.8 percent, the Labor and Finance Ministries said. The total number of jobseekers was 2.7 million. While claims have risen every month this year except in March, national statistics office Insee predicts the economy is about to begin creating jobs again for the first time in two years. “Total employment fell heavily in 2009, dragged down by the drop in activity,” Insee said late yesterday. “It should progress slightly over 2010 as a whole.”

Lagarde Says Pension Reform Is Priority, Sees AAA Rating Safe

June 25 (Bloomberg) — France’s plan to lift its retirement age is a signal to investors about the seriousness of President Nicolas Sarkozy’s intention to cut the budget deficit, Finance Minister Christine Lagarde said.

“The priority is to protect the retirement system,”

Lagarde said today on France Inter radio. “We are also trying to send a message of security to the markets.”

Sarkozy’s government set out proposals last week to raise the minimum age at which workers can tap the state pension to 62 in 2018 from 60 currently. The age at which full benefits are reaped is to rise to 67 from 65 under the plan, which labor unions protested yesterday.

France is the only country among Europe’s five biggest economies not to have presented a detailed savings plan for next year. Britain set out deficit-cutting measures totaling 113 billion pounds ($167 billion) earlier this week and Germany announced cuts of 81.6 billion euros ($101 billion) on June 7.

Sarkozy has committed to reducing the deficit from 8 percent of gross domestic product this year to 6 percent in 2011 and 3 percent in 2013.

Lagarde said “there’s no reason to think” that France’s AAA credit rating is threatened, though she said the country doesn’t have the luxury of time to debate the pension overhaul.

“We have time pressure, it’s not possible to delay,”

Lagarde said. “The public finance situation doesn’t allow for it. We need to take measures quickly.”

Sarkozy and Lagarde join leaders and finance ministers of the Group of Eight later today in Huntsville, Ontario, before meeting their Group of 20 counterparts tomorrow in Toronto.

Confindustria Raises Italian GDP Growth Forecast on Euro Drop

(Bloomberg) Italian gross domestic product will expand 1.2 percent this year and 1.6 percent in 2010, up from previous forecasts of 1.1 percent and 1.3 percent respectively, Confindustria said. The single currency’s 14 percent slide against the dollar this year will “more than offset” the impact of budget cuts worth 24.9 billion euros, which will shave 0.4 percentage points of GDP in 2011 and 2012, Confindustria said. Prime Minister Silvio Berlusconi’s deficit-curbing measures aim to reduce the budget deficit by an additional 1.6 percent of GDP, bringing the shortfall within the EU limit of 3 percent of GDP in 2012 from 5.3 percent last year.

Spanish May Producer Prices Advance Most in 19 Months on Oil

June 25 (Bloomberg) — Spanish producer-price inflation accelerated to the fastest in 19 months in May as higher oil prices boosted energy costs.

Prices of goods leaving Spain’s factories, mines and refineries rose 3.8 percent from a year earlier after a 3.7 percent increase in April, the National Statistics Institute in Madrid said today. That’s the biggest increase since October 2008. From the previous month, prices gained 0.2 percent.

Crude-oil prices rose 8 percent in the 12 months to the end of May, pushing up manufacturers’ costs. Still, with the economy continuing to shrink and the unemployment rate at 20 percent, consumer-price inflation remains restrained. Spain’s underlying inflation rate, which excludes volatile food and energy prices, turned negative in April for the first time on record.

The government forecasts the economy will contract 0.3 percent this year.

Spain May Cut 426-Euro Unemployment Subsidy, Cinco Dias Reports

June 25 (Bloomberg) — Spain’s Labor Minister Celestino Corbacho may cut a 426 euro-a-month ($525) subsidy paid to the unemployed whose two-year, contributions-based jobless benefit has run out, Cinco Dias reported.

The subsidy, which cost the state 1.2 billion euros since it was introduced last year, will be difficult to maintain after August as Spain tries to cut its deficit, the newspaper reported, citing an interview with Corbacho.

Greek optimistic on budget deficit reduction

(AP) Greece’s finance minister on Thursday voiced confidence that the country will meet or even surpass its ambitious targets to slash spending and boost revenues by the end of the year. “Have we won the bet? No,” George Papaconstantinou said. “But we have well-founded hopes and are optimistic that, for the first time in many years, at the end of the year the state budget will achieve or even exceed the targets we have set.” Papaconstantinou said his optimism was based on figures showing a 40 percent deficit reduction during the first five months of the year, as well an expected revenue boost from increased consumer taxes. On Friday the cabinet is set to approve a key draft law on pension and labor reforms. The government says the current pension system is not viable, and if left unchanged would come to absorb 24 percent of GDP in 2050, from the current 12 percent.

On Thu, Jun 24, 2010 at 7:37 AM, wrote:

you seem to be arguing that the fix is in for the eurozone. is that a correct read?

Yes, looks like it to me.

if so, then your expected rise in the euro could occur sooner rather than later.

Yes.

seems to me that it will be difficult for the euro to rally anytime soon as central banks / portfolio managers trim their euro exposure on any strength.

Right, the portfolio shifting may not have run its course yet. That’s the risk. I’m thinking a sell off in gold, which went up this last bit due to euro fears, will signal the turn in psychology/reduction in euro fear.

With restructuring risk already on the table, seems it has to be mainly discounted in that anyone who can readily shift out of euro already have, and for those still holding euro financial assets they probably have euro liabilities and don’t want to add currency risk by shifting out of euro?

I suppose the real test will be the next mini funding crisis to see how the euro handles that stress.

Makes sense.

i’m getting fixated on the whole monetarists vs keynesian showdown that seems to be unfolding. in my mind the Greenspan era conditioned traders to believe that monetary policy was all powerful and the solution to every bump in the road. with rates near zero almost everywhere that impression will certainly fade.

And rightly so. The reality is sinking in that the Fed has no more meaningful tools, and the ones they thought they had can only help liquidity, and not support aggregate demand beyond keeping it from getting worse due to liquidity issues.

at the same time, the magnitude of the financial crisis and now the Greek crisis has seriously damaged the credibility of deficit spending.

Yes, for the wrong reasons, but I agree that’s the perception that’s driving policy.

so here we are with little faith in either concept and no clear sign anywhere of the handoff from public sector to private sector demand growth.

Right, that hand off traditionally comes from a return of private sector credit expansion, mainly housing and cars, which still hasn’t taken hold in this cycle. With all the demand leakages of unspent income due to pension funds, corp reserves, etc, some entity has to spend more than its income to make up for that.

I see a big test of theory coming in the next few years with little ammunition to proactively fight.

interesting times for sure.

Depressing, too.

I’d like to live during at least one period of true prosperity that’s ours for the taking in this time of abundant resources and geometrically expanding technology.

As previously discussed, it is possible their deficits already got high enough and the euro low enough to support very modest growth when market forces intervened to stop further fiscal expansion.

One problem now is proactive cuts can set them back if a combination of private sector credit and exports doesn’t expand at the same time.

And expanding exports remains problematic as that would tend to strengthen the currency to the point where net exports remain relatively low, and there is nothing they can do to keep the euro down should that happen.

Another problem is the market forces that are working to limit their fiscal expansion will continue to hamper their ability to fund themselves, especially with continuing talk of ‘restructuring’ which, functionally, is a form of default.

I’ve read the ECB is now buying about 10 billion euro/week of national govt bonds in the secondary markets and ‘learning and demonstrating’ that it is not inflationary, doesn’t cause a currency collapse, and poses no operational risk to the ECB as some feared it might. As they all become ‘comfortable’ with this look for market forces to ‘force’ them to expand the buying geometrically as happened with their funding of their banking system, where much of the ‘risk’ is now at the ECB as they accept collateral for funding from their member banks that no one else will.

Operationally the ECB can fund the whole shooting match. And if they can address the moral hazard the usual way via the growth and stability pact, this time with the leverage of being able to threaten to cut off ECB funding to punish non compliance.

This ’solution’ of the ECB buying national govt debt in the secondary markets is conceptually/functionally nearly identical to my proposal of per capita distributions to the national govts by the ECB. The difference is my proposal would not have ‘rewarded bad behavior’ as theirs does, but that’s a relatively minor consideration for them at the moment, and if they continue doing what they are doing, they have ’saved the euro,’ even though having the ECB fund all the banks and national govts wasn’t their original idea of how it all would end up.

European Industrial Orders Increase for Third Month

Trichet Says Current Situation Requires ‘Credible Measures’

ECB’s Trichet Says Italian Budget Cuts Go in ‘Right Direction’

German debt agency asked to issue bonds

Schäuble defends German austerity

German Government Won’t Turn to Tax Cuts Amid Deficit Reduction

S&P’s Kraemer Sees No ‘Serious Risk’ of Euro Break Up

Merkel Defends Spending Cuts, Gets Backing From Trichet

Germany Sees Jobless Numbers at Under 3 Million

French Consumer Spending Gains on Signs Job Market Is Improving

French Economy to Expand 1.4% This Year on Exports, Insee Says

Zapatero Says Not Cutting Deficit Would Raise Interest Costs

Not my first choice of topic, but what they wanted me to discuss.

Currency movements are nearly impossible to accurately forecast due to continuous cross currents.

The overly flattering intro was a pleasant surprise that caught me out for a moment.
And I’ll shamelessly use it selectively to advance the cause.

>   
>   (email exchange)
>   
>   On Sat, Jun 12, 2010 at 10:09 AM, wrote:
>   
>   great…every exposure counts…….question on Euro call to 1.5-1.6 area
>   

Remember this is not ‘trading advice.’ In fact, the charts still look terrible so the portfolio shifting may be further from over than I suspect. It is a statement that the forces that brought the euro to those levels not long ago are still in place, though recently overpowered by the portfolio shifting.

>   
>   my understanding of what you’ve said previously is that the deflationary
>   measures to be followed by Greece, Spain, Portugal, Italy and Ireland would
>   bring about even lower growth in euro block and result in increasing strains
>   on the political union with the possibility of the euro group breaking apart
>   in some fashion with a continuing decline of the currency. Is this correct?
>   

yes.

>   
>   What are you saying now?..thanks
>   

Those same deflationary forces that scare some people out of the currency also make the currency more valuable.

Note that Japan hasn’t done particularly well yet the yen is a very strong currency.

Also, sometimes a nation growing rapidly has ‘automatic stabilizers’ in place that automatically increase tax collections and reduce transfer payments as growing private sector credit expansion fuels the growth. That can firm up a currency as well, as it also attracts equity type portfolio managers due to the growth environment.

Always lots of cross currents!

The eurozone deficits had seemed to have gotten maybe high enough to stabilize growth just as market forces shut down any thoughts of continued fiscal relaxation.

Those higher deficits softened the currency some and then fear took over with the default risk pushing the euro down further and gold up as well, also out of pure fear.

The euro then went low enough to apparently firm up exports, which also tends to firm up the currency.

Tightening up fiscally now puts a lid on growth and even threatens negative growth. The fledgling export recovery will work to shut itself down via euro appreciation with dollar buying-off balance sheet deficit spending and what would at least ‘make the numbers work’- prohibited ideologically.

And with their current monetary arrangements there isn’t much they can do except sit there and suffer the consequences of those arrangements.

The only bright sign is that the ECB may be sneaking towards interest rate targeting for the member nations outstanding debt, which can go a long way towards alleviating fears of credit risk for the national govts. But to do that the ECB has to be buying without notional limits, so it’s too soon to say that’s what’s happening.