The year and fiscal cliff is a looming disaster but it’s too soon for markets to discount a high chance of it actually happening.

Lower oil prices are helping the US consumer and the $US.

The stronger $US works against US exports some and earnings translations a bit as well. Weaker global demand also works against US exports.

Deficit spending in the euro zone has also been rising some, and after the latest rounds of austerity and subsequent deficit increasing weakness may total something close to 7% of GDP.

That should be enough to muddle through as well. Austerity hikes unemployment and deficits to the point where the resulting deficit is sufficient to sustain things. Without another round of austerity there should be some sort of stability of output and employment.

That is, while it’s doubtful the ‘new europe’ will engage in meaningful fiscal expansion, it may not proactively raise taxes and/or cut spending in any meaningful way, either.

So as the member nations stumble their way through each successive securities auction, it won’t surprise me if their economies sort of stabilize around 0 growth or so. And then begin to pick up a tiny bit. All supported by the current, higher levels of deficit spending.

And the lower euro could help their exports some as well.

Yes, there will be all kinds of credit related vol, but under it all there will be sales and profits taking place. The businesses that are still around are the survivors who know how to get by in this kind of economy, where, while slower than it ought to be, there is still about $40 trillion worth of goods and services getting bought/sold in the US and Europe. GDP growth has gone to near 0, but not GDP itself.

Also, Trichet Friday, the German elections, and G8 reports seem to be setting the tone for the euro zone to do something about the solvency issue. This is very good for equities and the rest of the credit stack.

At the same time it does not seem likely that any growth proposals will include fiscal relaxation, so the euro zone will have to get by the best it can with the deficits it has, which I’d guess should mean flat GDP, +/- 1% or so.

The US should also continue to muddle through with modest top line growth, and inflation low enough and the output gap wide enough to keep this Fed from hiking any time soon.

This is serious progress:

Ex-ECB Chief Trichet Unveils Bold Plan to Save Euro

May 17 (Reuters) — Europe could strengthen its monetary union by giving European politicians the power to declare a sovereign state bankrupt and take over its fiscal policy, the former head of the European Central Bank said on Thursday in unveiling a bold proposal to salvage the euro.

The plan offered by Jean-Claude Trichet, who stepped down last November as ECB president, would address a fundamental weakness of the 13-year-old single currency, the survival of which is threatened by the Greek crisis.

The monetary union has always defied economic principles, because the euro was launched ahead of European fiscal or political union. This has caused strains for countries running huge budget deficits – namely Greece, Portugal, Ireland, Spain and Italy – that have led to financing difficulties and over-stretched banking systems.

For the European Union, a fully fledged United States of Europe where nation states cede a large chunk of fiscal authority to the federal government appears politically unpalatable, Trichet said.

An alternative is to activate the EU federal powers only in exceptional circumstances when a country’s budgetary policies threaten the broader monetary union, he said.

“Federation by exception seems to me not only necessary to make sure we have a solid Economic and Monetary Union, but it might also fit with the very nature of Europe in the long run. I don’t think we will have a big (centralized) EU budget,” Trichet said in a speech before the Peterson Institute of International Economics here.

“It is a quantum leap of governance, which I trust is necessary for the next step of European integration,” he said.

His proposal was presented in Washington on the eve of the G8 meeting of the world’s major economies, hosted by U.S. President Barack Obama who will press Europe to intensify its efforts to resolve the sovereign debt crisis, which threatens a fragile global recovery.

It also comes ahead of a critical meeting of EU leaders on May 23 to discuss ways to support growth. Its strict budgetary policies to date have led to recessions in many countries, political unrest and in Greece a political stalemate after recent elections.

Trichet said the building blocks already are in place for moving ahead with his fiscal plan.

Countries have agreed to surveillance of each other’s budgets and they have agreed to levy fines on countries that run excessive budget deficits, giving them fiscal oversight authority.

The next step would be to take a country into receivership when its political leaders or its parliament cannot implement sound budgetary policies approved by the EU. The action would have democratic accountability if it were approved by the European Council of EU heads of states and the elected European Parliament, he said.

The idea earned a warm reception from leading economists and prominent Europeans attending the session.

“It is a very radical proposal, couched as a modest step,” said Richard Cooper, international economist at Harvard.

Caio Koch Weser, former German economics minister, said he found it “very attractive” because it addresses the problem of a strong European Central Bank, a weak European Commission which acts as the EU’s executive branch, and a confused European Council, which provides political leadership.

Lower crude prices should also help some.

I had guessed the Saudis would hold prices at the $120 Brent level, given their output of just over 10 million bpd showed strong demand
and their capacity to increase to their stated 12.5 million bpd capacity remains suspect. And so with the Seaway pipeline now open (last I heard)
to take crude from Cushing to Brent priced markets I’d guessed WTI would trade up to Brent.

But what has happened is the Saudi oil minister started making noises about lower prices and when ‘market prices’ started selling off the Saudis ‘followed’ by lowering their posted prices, sustaining the myth that they are ‘price takers’ when in reality they are price setters.

So to date, contrary to my prior guess, both wti and brent have sold off quite a bit, and cheaper imported crude is a plus for the US economy. Which is also a plus for the $US, as a lower import bill makes $US ‘harder to get’ for foreigners.

But the trade for quite a while has been strong dollar = weak US stocks due to export pricing/foreign earnings translations, and also because US stocks have weakened on signs of euro zone stress, which has been associated with a weaker euro. So when things seem to be looking up for the euro zone, the euro tends to go up vs the dollar, with US stocks doing better with any sign of ‘improvement’ in the euro zone.

It’s all a tangled case of cross currents, which makes forecasting anything particularly difficult.

Not to mention possible dislocations from the whale, which may or may not have run their course, etc.

And then there’s the news from Greece.

First, they made a full bond payment yesterday of nearly 500 million euro to bond holders who did not accept the PSI discounts. This is confounding for the obvious reasons, signals it sends, moral hazard, credibility, etc. etc. But it’s also a sign the politicians are doing what they think it takes to keep the euro going as the currency of the euro zone. Same goes for the decision to fund Greece as per prior agreements even when there is no Greek govt to talk to, and lots of signs any new govt may not honor the arrangements.

Even if that means tricking private investors out of 100 billion, rewarding those who defy them, whatever. Tactics may be continuously reaching new lows but all for the end of keeping the euro as the single currency.

It also means that while, for example, 10 year Spanish yields may go up or down, the intention is for Spain, one way or another, to fund itself, even if short term. Doesn’t matter.

And more EFSF type discussions. The plan may be to start using those types of funds as needed, keeping the ECB out of it for that much longer, regardless of where longer term bonds happen to trade.

As for the euro zone economy, yes, growth is probably negative, but if they hold off on further fiscal adjustments, the 6%+ deficit they currently are running for the region is probably, at this point, enough to muddle through around the 0 growth neighborhood. The upside isn’t much from there, as with limited private sector credit growth opportunities, and substantial net export growth unlikely, and strong ‘automatic stabilizers’ any growth could be limited by those automatic fiscal stabilizers. Not to mention that this type of optimistic scenario likely strengthens the euro and keeps a lid on net exports as well.

And sad that this ‘bullish scenario’ for the euro zone means their massive output gap doesn’t even begin to close any time soon.

For the US, this bullish scenario has similar limitations, but not quite as severe, so the output gap could start to narrow some and employment as a percentage of the population begin to improve. But only modestly.

The US fiscal cliff is for real, but still far enough away to not be a day to day factor. And it at least does show that fiscal policy does work, at least according to every known forecaster with any credibility, which might open the door to proactive fiscal? Note the increasing chatter about how deficits don’t seem to drive up interest rates? And the increasing chatter about how the US, Japan, UK, etc. aren’t like the euro zone members with regards to interest rates?

Same in the euro zone, where discussion is now common regarding how austerity doesn’t work to grow their economies, with the reason to maintain it now down to the need to restore solvency. This is beginning to mean that if they solved the solvency riddle some other way they might back off on the austerity. And now there is a political imperative to do just that, so things could move in that direction, meaning ECB support for member nation funding, directly or indirectly, which removes the ‘ponzi’ aspect.

One would think something so obvious and ‘in their face’ year after year, decade after decade, might get their attention…

Hollande faces budget shortfall test

(FT) François Hollande has promised that he would take whatever measures necessary to rein in France’s heavy public debt, which is rising close to 90 per cent of gross domestic product. He knows that to win backing for his growth initiative from German chancellor Angela Merkel depends on assuring her that France will meet its obligations on its own public finances. The European Commission’s forecast projected a budget deficit next year of 4.2 per cent, compared to the target of 3 per cent set by Brussels and to which Mr Hollande is committed. That amounts to a gap of some €24bn. Mr Hollande is unlikely to give further details of his plans until he gets an independent report on the public finances at the end of June (after National Assembly elections).

Dutch austerity consensus unravels

(FT) Freedom party leader Geert Wilders brought down the country’s ruling coalition last month when he pulled out of talks over budget cuts needed to meet strict EU deficit limits, triggering elections scheduled for September 12. Mr Wilders is campaigning fiercely against what he calls the government’s “subservience” to Brussels’ demands for budget cuts. A poll released on Monday suggests voters are turning against the last-minute budget deal reached after the government fell between the ruling liberals and centre-left opposition parties. The April 26 deal pledged the Netherlands to meet an EU deadline to slash its 2013 budget deficit to below 3 per cent of gross domestic product, down from a projected 4.7 per cent.

Greece’s Tsipras: We Want Euro, but Not Austerity

By Michelle Caruso-Cabrera and Jennifer Leigh Parker

May 10 (CNBC) — The head of Greece’s Radical Left Coalition, Alexis Tsipras, told CNBC Thursday that he will “go as far as I can” to keep Greece in the euro zone, despite declaring earlier this week that the Greek bailout agreement is “null and void” and should be abandoned.

Tsipras (pronounced SEE-Pras), who was unable to form a coalition government this week after his party came second in Sunday’s election, said a Greek exit from the euro zone would be “disastrous.”

Tsipras said he is willing to negotiate with the so-called troika — the International Monetary Fund , the European Union, and theEuropean Central Bank — to keep Greece in the euro zone.

CIC Stops Buying Europe Government Debt on Crisis Concern

By Andres R. Martinez

May 10 (Bloomberg) — Gao Xiqing, president of China Investment Corp., said the nation’s sovereign wealth fund has stopped buying European government debt on concerns about the region’s financial turmoil.

CIC will continue to look for new investments in Europe as part of its strategy to boost allocations to infrastructure, private-equity assets as well as emerging markets to help boost returns, Gao said. CIC, with an estimated $440 billion in assets, is the world’s fifth-largest country fund, according to Sovereign Wealth Fund Institute.

“What is happening in Europe right now is of course of concern,” Gao said in an interview in Addis Ababa, Ethiopia, during the World Economic Forum on Africa. “We still have our people looking at opportunities in Europe, even though we don’t want to buy any government bonds.”

Europe’s turmoil is reigniting on the second anniversary of policy makers’ first attempt to prevent Greece’s woes from spreading. That raises fresh doubt over the strategy just as Greece’s election spurs concern that the country may not meet the terms of its international rescues and will seek a solution outside the euro.

61% Believe Europe Needs to Cut Government Spending to Save Economy

May 9 (Bloomberg) — Newly elected leaders in France and Greece have signaled that austerity efforts in their countries may be coming to an end, but as far as Americans are concerned, that’s a move in the wrong direction. A new Rasmussen Reports national telephone survey finds that 61% of American Adults believe cuts in government spending would do more to improve the economic and financial situation in France and Greece than increases in that spending. Just 20% think more government spending is the better way to go. Eighteen percent (18%) are not sure. (To see survey question wording, click here.)

The survey of 1,000 Americans nationwide was conducted on May 7-8, 2012 by Rasmussen Reports. The margin of sampling error is +/- 3 percentage points with a 95% level of confidence. Field work for all Rasmussen Reports surveys is conducted by Pulse Opinion Research, LLC. See methodology.

Also, unfortunately, the non MMT world pretty much still fails to grasp that mass unemployment is a macro problem and a manifestation of unspent income. That the only way the output gap gets filled is by some sector spending more than its income; and that the issuer of the currency is the only entity that isn’t inherently revenue constrained when it spends.

EU’s Response to Crisis Will ‘Convince People,’ Van Rompuy Says

May 9 (Bloomberg) — European Union President Herman Van Rompuy said the EU’s response to the sovereign-debt crisis will “convince people” of the value of being in the 27-nation bloc.

“We will convince people of the sense and the meaning of EU membership by results,” Van Rompuy said in a question-and- answer session posted on the Euronews website today. “That’s why we have to stabilize the euro zone and that’s why we have to increase economic growth and create jobs.”

“There is still a huge majority in most of the countries for membership of the European Union and the euro zone,” Van Rompuy said. “Even in Greece, I saw an opinion poll just before the election which said that 75 percent of people don’t want to leave the euro zone.”