Draghi Signals Euro Strength May Hurt ECB’s Recovery Efforts

The problem is there’s nothing he can do about it short of backing off on supporting fiscal austerity.

Buying fx is not an option ideologically, as it would give the appearance that the fx reserves are backing the euro.

Late addition:
One more thing, Japanese buying of member nation euro bonds necessarily weakens the yen.

So does Draghi want that to stop/rates to go up?

Draghi Signals Euro Strength May Hurt ECB’s Recovery Efforts

By Matthew Brockett and Stefan Riecher

Feb 7 (Bloomberg) — “The exchange rate is not a policy target, but it is important for growth and price stability,” ECB President Mario Draghi said at a press conference. “We want to see if the appreciation is sustained, and if it alters our assessment of the risks to price stability.” Draghi noted that the ECB will publish new economic projections next month and stressed that officials will “maintain our accommodative monetary stance.” Draghi said economic weakness will prevail only “in the early part” of this year and “later in 2013, economic activity should gradually recover, supported by our accommodative policy stance.” Still, risks to the economic outlook remain on the downside, he said. Draghi said if monetary policies produced “consequences on the exchange rate that do not reflect the G-20 consensus, we will have to discuss this.”

Aso: Yen Has Weakened More Than Intended

Now they give the nod to their life insurance companies and pension funds to back off?

Aso: Yen Has Weakened More Than Intended

Feb 8 (Reuters) — Japanese Finance Minister Taro Aso said on Friday that the yen has weakened more than intended during its recent decline to around 90 per dollar from around 78 yen a few months ago.

The dollar fell about 1 percent versus the yen shortly after Aso comments, as traders pared bets on further declines in the Japanese currency.

Since November, the yen has fallen around 16 percent versus the dollar in anticipation that new Prime Minister Shinzo Abe will push his agenda of aggressive monetary policy easing to weaken the currency.

The finance minister’s comments indicate some surprise within the government at how quickly those expectations among traders translated into declines in the yen.

“It seems that the government’s policies have fueled expectations and the yen weakened more than we intended in the move to around 90 from 78,” Aso told lawmakers in the lower house budget committee.

Recently, Aso has reacted strongly to criticism from German and other European officials that Japan is intentionally trying to weaken its currency with monetary easing, so his comments on Friday could cause some confusion about Japan’s currency policy.

The dollar fell 1.3 percent on the day to 92.29 yen. The dollar hit an almost 3-year high of 94.075 yen earlier in the week on expectations the Bank of Japan will pursue aggressive monetary easing to shore up the economy.

Abe, while campaigning for an election last year, repeatedly said his economic policy had three arrows: monetary policy easing, fiscal spending and structural reforms to increase competitiveness.

Abe, since taking office in December, has put the central bank under relentless pressure to do more to lift the economy and made it clear he wants someone in the job who will be bolder than the outgoing BOJ chief in loosening monetary policy.

Current BOJ Governor Masaaki Shirakawa will leave his post on March 19.

Last month,the BOJ signed a joint statement with the government adopting a new 2 percent inflation target as a sign of its commitment to fighting deflation. It also announced a shift to “open-ended” asset buying.

Officials from the Group of 20 economic powers say that although top economic policymakers are likely to discuss how Japan’s new monetary stance is weakening the yen when they meet next month, they will stop short of calling it a competitive devaluation.

Fiscal Devaluation in Europe

It’s a policy designed to drive exports.
A form of protectionism.
It reduces consumption of imports to the extent domestic prices are helped by lower labor costs where domestic goods a compete directly with imports, which is probably limited.

And of course without further support of fx intervention (dollar and yen buying etc.) it makes the currency go up to the point where the effects are offset/no gains in employment, etc.

And if one nation does it the currency move hurts the others who don’t so it opens up a race to the bottom.

Recap:
It hurts low income consumers
It helps corporate profits
It supports the currency
And so those are the people that support it.
:(

Am I missing something?

Harvards Gopinath Helps France Beat Euro Straitjacket

By Rina Chandran

Feb 6 (Bloomberg) — When French President Francois Hollandeunveiled a plan in November for a business tax credit and higher sales taxes as a way to revive the economy, he was implementing an idea championed by economist Gita Gopinath.

Gopinath, 41, a professor at Harvard University in Cambridge, Massachusetts, has pushed for tax intervention as a way forward for euro-area countries that cannot devalue their exchange rates. Fiscal devaluation is helping France turn the corner during a period of extreme budget constraints, former Airbus SAS chief Louis Gallois said in a business- competitiveness report Hollande commissioned.

She advocated fiscal devaluation for Europes currency union in a 2011 paper she co-authored with her colleague Emmanuel Farhi and former student Oleg Itskhoki, an assistant professor at Princeton in New Jersey.

Despite discussions in policy circles, there is little formal analysis of the equivalence between fiscal devaluations and exchange-rate devaluations, they wrote. This paper is intended to bridge this gap.

The paper examines a remarkably simple alternative that doesnt require countries to abandon the euro and devalue their currencies, Gopinath said. By increasing value-added taxes while cutting payroll taxes, a government can create very similar effects on gross domestic product, consumption, employment and inflation.

The higher VAT raises the price of imported goods as foreign companies pay the levy. The lower payroll tax helps offset the extra sales tax for domestic companies, reducing the need for them to raise prices. Since exports are VAT exempt, the payroll-cost saving allows producers to sell goods cheaper overseas, simulating the effect of a weaker currency, according to the paper.

The policy also can help on the fiscal front, as increased competitiveness can lead to higher tax revenue, Gopinath said.

Hollande is seeking to revive Frances competitive edge by offering companies a 20 billion-euro ($27 billion) tax cut on some salaries as he attempts to turn around an economy that has barely grown in more than a year. He also will lift the two highest value-added tax rates. The plan was inspired partly by Gopinaths paper, said Harvard professorPhilippe Aghion, an informal campaign adviser to Hollande, who was elected president in May.

Aghion, who co-wrote a column in Le Monde newspaper last October advocating Gopinaths theory, said Gallois proposed to Hollande that its the right strategy for France. Gallois is slated to become a member of the board at automaker PSA Peugeot Citroen this year.

We contributed to the adoption of the policy by Hollande, and Gallois called to thank me, Aghion said in a telephone interview. There is wider interest in the policy. Italy, Spain, Greece — they should all be interested. Its an idea that would work.

Japan Pension Funds Bonds Too Many If Abe Succeeds, Mitani

For all practical purposes this is about and part of ‘official policy’ to weaken the yen if they do it.

That is, it’s not a reaction to govt policy, it is govt policy.

Japan Pension Funds Bonds Too Many on Abe Plan, Mitani Says

By Anna Kitanaka, Toshiro Hasegawa & Yumi Ikeda

Feb 4 (Bloomberg) — Japans public pension fund, the worlds biggest manager of retirement savings, is considering the first change to its asset balance as a new governments policies could erode the value of $747 billion in local bonds.

Managers of the Government Pension Investment Fund, which oversees about 108 trillion yen ($1.16 trillion) in assets, will begin talks in April about reducing its 67 percent target allocation to domestic bonds, President Takahiro Mitani said in a Feb. 1 interview in Tokyo. The fund may increase holdings in emerging market stocks and start buying alternative assets.

The GPIF, created in 2006, didnt alter the structure of its holdings during the worst global financial crisis in 80 years or in response to the 2011 earthquake and nuclear disaster. Prime Minister Shinzo Abe and the Bank of Japan (8301) have pledged to restore economic growth and spur inflation, which will mean higher interest rates, Mitani said.

If we think about the future and if interest rates go up, then 67 percent in bonds does look harsh, said Mitani, who was appointed in 2010 after serving as an executive director at the Bank of Japan. We will review this soon. We will begin discussions for this in April-to-May. Any changes to our portfolio could begin at the end of the next fiscal year.

GPIF, one of the biggest buyers of Japanese government bonds, held 69.3 trillion yen, or 64 percent of total assets, in domestic debt at the end of September, according to its latest quarterly financial statement. That compares with 12 trillion yen, or 11 percent, in Japanese stocks; 9.6 trillion yen, or 9 percent, in foreign bonds; and 12.6 trillion yen, or 12 percent, in overseas stocks.

Relative Yield

The fund, which took over management of government employee retirement savings when it was set up, returned to profit in the three months ended Dec. 31 from a 1.4 percent loss in the first six months of the fiscal year, Mitani said. He declined to be more specific. It needs to raise about 6.4 trillion yen this fiscal year through March 31 to meet payments.

The yield on Japans 10-year government bond climbed 3.5 basis points to 0.8 percent as of 4:35 p.m. in Tokyo today. By comparison, the projected dividend yield for the Topix Index (TPX), the countrys broadest measure of equity performance, is 2.05 percent. The Topix added 1.4 percent today.

Japans bonds handed investors a 1.8 percent return in 2012, according to a Bank of America Merrill Lynch Index, compared with the 18 percent surge in the Topix.

Even as shares jumped amid optimism surrounding Abes stimulus plans, benchmark Japanese government bond yields have remained below their five-year average yield of 1.18 percent. Benchmark 10-year yields are the lowest in the world after Switzerland and are less than half the level in the U.S.

Rates Outlook

JGBs were how we made money over the past 10 years, Mitani said. The BOJ said that they are increasing buying bonds, but theyre also putting power into lowering interest rates. If the economy gets better, then long-term interest rates like a 10-year yield at less than 1 percent are unlikely.

The five-year JGB rate touched a record low 0.14 percent last month amid speculation the Bank of Japan will expand bond purchases as part of the monetary easing advocated by Abe.

The comments by Mitani show the pension manager needs to consider higher-risk, higher-yield assets to help fund retirements of the worlds oldest population. About 26 percent of the nation is older than 65, according to data compiled by Bloomberg.

Under Mitanis leadership, the GPIF began buying emerging- market assets in September 2011 and started purchasing shares in countries included in the MSCI Emerging Market Index (MXEF) last year. Mitani said in July 2012 that the fund was selling JGBs to pay for peoples entitlements and might consider alternative investments as it seeks better returns.

100 Years

We havent changed the core portfolio for a long time so it was thought that its about time to review this, Mitani said. The portfolio was based on a prerequisite of things such as long-term interest rates at 3 percent on average for the next 100 years. Whether this is good will be a possible point of discussion.

Holdings have been broadly unchanged since inception, when the fund was formulated with an outlook for consumer prices to rise 1 percent annually. Instead, the nations headline CPI has fallen an average 0.1 percent each month since the start of 2006, according to data compiled by Bloomberg.

The Bank of Japan last month doubled its inflation target to 2 percent, a level last seen in 1997, when a sales tax was increased, with no sustained price gains of that magnitude in two decades. Falling prices reduce incentives to borrow and invest in new business projects, erode tax receipts and increase the attractiveness of saving in cash rather than spending or putting money into stocks or bonds.

Topix Surge

GPIF is the biggest pension fund in the world by assets, followed by Norways government pension fund, according to the Towers Watson Global 300 survey in August.

Japans Topix Index surged 30 percent from Nov. 14, when elections were announced, through Feb. 1 on optimism the Liberal Democratic Party will lead the economy out of recession and end deflation. The yen weakened almost 14 percent against the dollar in that time, and touched its lowest level since May 2010 last week.

Even after 12 straight weekly advances, the longest streak in 40 years, the Topix is still 67 percent below its December 1989 record high.

Relative Value

The measure trades for 1.1 times the value of net assets. That compares with 2.3 times for the S&P 500, 1.6 times for the Hang Seng Index and 1.9 times for the MSCI World Index. A reading above one means investors are paying more for a company than the value of its net assets.

The yen dropped 11 percent last year versus the dollar, the most since 2005. A weaker yen increases the value of exports and typically raises import costs, boosting consumer prices.

Japanese stocks do not look expensive, Mitani said. Were still in the middle of a rising stocks, weakening yen trend. It will continue for a while.

a word on the euro, US deficit doves, and Japan

As previously discussed, the euro looks to keep going up until the trade surplus reverses. Problem is the strong euro doesn’t necessarily cause the trade surplus to reverse, at least not in the short term. But it does tend to work against earnings and growth. And there’s nothing the ECB can do about it, short of buying dollars via direct intervention, which would be counter to their core ideology, as building dollar reserves would give the appearance of the dollar backing the euro. The solvency issue has now been behind them for quite a while, and still no sign of any ‘official’ recognition that deficits need to be higher to restore output and employment.

And, also as previously discussed, while the future was looking up for the US a few months ago, the caveat of ‘austerity’ has come into play with the year end FICA and other tax hikes, and now the odds are the sequesters are allowed to come into play March 1 as well. Note this has been Japan’s policy as well- fiscal tightening at the first sign of any hope for expansion. Fed policy also looks to remain restrictive as blatantly evidenced by the recent turn over of some $90 billion of ‘profits’ to the Treasury that otherwise would have been earned by the economy.

The headline ‘deficit doves’ pushing for larger deficits with their ‘out of paradigm’ arguments are also serving to continue to support austerity. They have been arguing that the low interest rates are a signal from the markets (as if they know anything about markets) indicating the economy wants the govt to sell more bonds. This is in response to the hawk’s equally out of paradigm argument that financing deficits will eventually drive up interest rates. So now that interest rates have started going higher, the dove’s case is for higher deficits is pretty much gone, removing the resistance to ‘getting our fiscal house in order’ just as the sequester date is approaching. Whether it’s gross ignorance or intellectual dishonesty doesn’t matter all that much at this point- it’s happening. At the same time oil and gasoline prices have been creeping up, taking a few more shekels away from consumers. January and it’s strong equity inflows/allocations and releases of December’s stats ends tomorrow. February’s releases of Jan stats will bring more post FICA hike clarity.

Japan’s weak yen, pro inflation policy seems to have been all talk with only a modest fiscal expansion to do the heavy lifting. Changing targets does nothing, nor does the BOJ have any tools that do the trick as evidenced now by two decades of using all those tools to the max. And while I’ve been saying all the while that 0 rates, QE, and all that are deflationary biases that make the yen stronger, there is no sign of that understanding even being considered by policy makers, so expect more of same. What has been happening to weaken the yen is a quasi govt policy of the large pension funds and insurance companies buying euro and dollar denominated bonds, which shifts their portfolio compositions from yen to euros and dollars, thereby acting to weaken the yen. I have no idea now long this will continue, but if history is any guide, it could go on for a considerable period of time. Yes, it adds substantial fx risk to those institutions, but that kind of thing has never gotten in the way before. And should it all blow up some day, look for the govt to simply write the check and move on.

Friday update

So just like Japan, as soon as the economy starts doing a bit better we hike taxes. Still too early to say how the FICA hike will impact sales and profits, but it will. And spending cuts are on the way, though they may be delayed.

Not to forget the debt ceiling thing about to be kicked 3 months down the road as it stands guard to ensure ‘meaningful’ spending cuts.

Oil firm, but can still go either way. WTI converging to Brent indicates the seaway pipeline capacity increase may be enough to drain the surplus at pad 2, bringing wti up to brent, but too soon to tell for sure. And looks like the demand for saudi crude is dropping some, but not enough to dislodge them from being
swing producer/price setter.

Looks to me like the whole world is becoming ‘more competitive’ so it all cancels out. Bad for people, ok for stocks, with profits running at record highs as a % of GDP. Meaning the federal deficit has to be that much higher, all else equal, to fill the output gap.

The yen keeps going down. Looking more and more to me it’s off the radar screen intervention by the likes of insurance co’s, pension funds, and other quasi govt agencies got the note to buy fx denominated bonds in size. Not sure how far they will take it, but they have a serious herd instinct that has formed serious multi year bubbles in the past.

Europe? They fixed the solvency issue, sort of, and now just have the economy thing to deal with. Problem is the ECB grants solvency only with conditionality. Good luck to them.

ecb getting there?

>   
>   (email exchange)
>   
>   On Jan 6, 2013 6:41 AM, Andrea wrote:
>   
>   Some interesting points made by Ulrich Bindseil and Adalbert Winkler (ECB) in
>   their October 2012 paper
>   
>   How about these authors rethinking fiscal policy in the light of this?
>   ;-)
>   

The results of our analysis are as follows:

A central bank that operates under a paper standard with a flexible exchange rate and without a monetary financing prohibition and other limits of borrowings placed on the banking sector is most flexible in containing a dual liquidity crisis.

• Raising interest rates to attract funding / capital inflows, while being the standard economic mechanism in normal times, may fail to equilibrate demand and supply in a confidence crisis as higher interest rates make it less likely that borrowers will be able to serve the debt. As a result, within any international monetary system characterized by some sort of a fixed exchange rate, the availability of inter-central bank credit determines the elasticity of a crisis country’s central bank in providing liquidity to banks and financial markets, notably government bond markets. Thus, the sustainability of fixed exchange rate systems depends on the elasticity of inter-central bank credit, i.e. the ability and willingness of the central banks of “safe haven countries” to provide loans to central banks of countries in financial distress (gold standard and peg to another country’s currency) and on the elasticity of liquidity provision by the common central bank (monetary union).

• In a monetary union, like the euro area, international arrangements are replaced by a common central bank that provides lender-of-last-resort lending to banks. In the institutional set-up of the euro area where national central banks are in charge of the actual conduct of central bank operations with a country’s banking system, this provision of liquidity is reflected in the “TARGET2 balances”. At the same time, the comparison of a central bank of a euro area type monetary union with a country central bank operating under flexible exchange rates and a paper standard, like the US Federal Reserve, shows that central banks under the former framework have a similar capacity in managing dual liquidity crises as long as the integrity of the monetary union is beyond any doubt.

• Collateral constraints matter systematically under all monetary frameworks. As a result, a central bank confronted with a dual liquidity crisis has to be in a position to adjust collateral constraints in order to enhance the elasticity of its liquidity provision and to limit bank defaults and a deepening of the crisis. If done prudently, this may actually reduce central bank risk taking.

• Banks and securities markets can be subject to a liquidity crisis. However, while lender of last resort activities vis-à-vis banks are a widely accepted toolkit of a central bank, outright purchases of securities have been a controversial tool of central bank liquidity provision in financial crisis since the days of the real bills doctrine. Monetary financing prohibitions (regarding Governments) are a specific case of banning direct lending or primary market purchases of securities, namely securities issued by governments. If the central bank is either not allowed, or it is unwilling to conduct outright purchases of securities, the banking sector – supported by the central bank – can in principle act as the lender of last resort for debt securities markets. However, this is subject to additional constraints, i.e. the banks’ ability and willingness to perform this role. Moreover, it has specific drawbacks as, for instance, the possibility of diabolic solvency loops between banks, the issuers of debt securities, including the government and the real economy may arise.

• Borrowing limits of banks, i.e. quantitative credit constraints deliberately imposed by the central bank to limit the borrowing of banks from the central bank, accelerate a crisis because – if enforced – they signal to banks and markets that at those limits the central bank’s elasticity of liquidity provision ends. As a result, those limits push all banks (potentially) affected into a state of fear of becoming illiquid and hence into a state of strict liquidity hoarding.

Japan- Foreign countries have no right to lecture us

This confirming much of what’s been previous discussed.

The remaining question whether there already has been direct intervention, as evidenced by rising fx reserves.

Interestingly, with floating fx it’s operationally easy for Central Banks to offset each other’s intervention. For example, if the BOJ buys dollars the Fed could simply buy the yen. Each CB would have a deposit on the other’s books and the (global) economy wouldn’t know the difference.

Also interestingly, all governments currently miss the point that exports are real (real vs nominal) costs and imports are real benefits.

So the CB that weakens its currency is in fact gifting the world superior real terms of trade via lower export prices via lower domestic real wages, etc. as it reduces its own real terms of trade.

Japan Rebuke to G-20 Nations May Signal More Moves to Weaken Yen

By Eunkyung Seo and Masaki Kondo

December 31 (Bloomberg) — Japanese purchases of foreign bonds to weaken the yen may become more likely as the nation rejects trading partners’ rights to criticize its currency policies.

“Foreign countries have no right to lecture us,” Finance Minister Taro Aso told reporters at a briefing in Tokyo on Dec. 28. He said that the U.S. should have a stronger dollar and questioned whether major Group of 20 nations had stuck to pledges from 2009 to avoid competitive currency devaluations.

Japan’s new Prime Minister Shinzo Abe may accept trade friction as a cost of spurring growth and countering deflation through a looser monetary policy and weaker yen. The currency is set to complete its biggest annual decline in seven years after Abe’s Liberal Democratic Party secured a landslide victory in this month’s lower-house election. During his campaign, Abe said foreign-bond purchases were a possible monetary tool.

“The LDP wants to boost stock prices before the upper- house election in July next year, and the easiest option for them is to weaken the currency,” said Satoshi Okagawa, a senior global-markets analyst in Singapore at Sumitomo Mitsui Banking Corp., a unit of Japan’s second-biggest bank by market value. “The explicit policy to weaken the yen is likely to upset the U.S. and China.”

The yen was at 86.08 per dollar as of 7:30 a.m. in London after touching 86.64 on Dec. 28, the weakest since August 2010. It traded at 113.53 per euro.

Currency Promises

The currency has dropped more than 10 percent versus the greenback since the end of 2011, set to complete the biggest annual slump since 2005. At the same time, the yen remains about 30 percent higher than it was five years ago.

In his Dec. 28 comments, Aso, a former prime minister, said that Japan and other countries made “a promise not to resort to competitive currency devaluations” at a G-20 meeting in 2009. “How many countries have kept the promise? The U.S. should have a stronger dollar. What about the euro?” he asked. “Foreign countries have no right to lecture us” as Japan is the only major economy to keep the pledge, Aso said.

The U.S. criticized Japan for undertaking unilateral sales of the yen in August and October last year, after Group of Seven economies earlier jointly intervened to weaken the currency in the aftermath of an earthquake and tsunami.

“Rather than reacting to domestic ‘strong yen’ concerns by intervening to try to influence the exchange rate, Japan should take fundamental and thoroughgoing steps to increase the dynamism of the domestic economy,” the Treasury Department said in a report in December last year.

Shrinking Economy

The Liberal Democratic Party faces the task of reviving growth after the economy contracted for the past two quarters, meeting the textbook definition of a recession. The nation’s industrial output tumbled more than forecast in November to the lowest level since the aftermath of last year’s record quake.

At the same time, stock prices are climbing, with Toyota Motor Corp. at a more than two-year high, as a weaker yen and prospects for central-bank easing brighten the outlook for exporters. Such improvements may cause concern for some of Japan’s Asian neighbors.

“South Korea is one of the countries most vulnerable to the weak yen policy as many export items are in direct competition, such as cars and electronic goods,” said Lee Sang Jae, a Seoul-based economist at Hyundai Securities Co. “Japan will try whatever it can to stop the deflation and to weaken the yen for export growth.”

Shirakawa’s Caution

After a Dec. 28 call with U.S. Treasury Secretary Timothy F. Geithner, Aso said he had told Geithner that the yen was making some corrections from one-sided moves and Aso would keep monitoring changes in the currency.

Bank of Japan (8301) Governor Masaaki Shirakawa, whose five-year term ends in April, has rejected suggestions that the bank buy foreign bonds and called for respect for the BOJ’s independence. Such a policy would amount to currency intervention, which is the responsibility of the finance minister, he says.

At the same time, the Nikkei newspaper on Dec. 29 cited Shirakawa as saying that central bank and government must work together to overcome deflation. Abe is pressing for the Bank of Japan to adopt a 2 percent inflation target, compared with a current goal of 1 percent. Consumer prices excluding fresh food fell 0.1 percent in November from a year earlier, showing the central bank is struggling to fulfil even the lesser ambition.

The LDP proposed in its campaign manifesto establishing a joint BOJ, Ministry of Finance and private sector fund to buy foreign bonds. Takatoshi Ito, a former finance ministry official and a possible contender to become central-bank governor, said in a Dec. 6 interview that the BOJ “can and should buy foreign bonds,” adding that such a move is possible if the finance minister publicly declares support for it.

In a note this month, Australia and New Zealand Banking Group Ltd. said that foreign bond purchases are contrary to the legislation governing the BOJ. At the same time, it’s possible that the government may cajole the central bank into putting money into a proposed private-public vehicle for investment in foreign asssets, the lender said.

quick look ahead for the euro zone

After describing since inception how the euro zone was going to get to where it is, here’s my guess on what’s coming next.  

First, to recap, it took them long enough and it got bad enough before they did it, but they did decide to ‘do what it takes’ to end the solvency issues and, after the Greek PSI thing, make sure the markets stopped discounting defaults as subsequently evidenced by falling interest rates for member nation debt.

But it’s solvency with conditionality, and so while they solved the solvency and interest rate issue, the ongoing austerity requirements have served to make sure the output gap stays politically too wide.  The deficits are high enough, however, for an uneasy ‘equilibrium’ of
near/just below 0% overall GDP growth and about 11% unemployment.

However, all of this is very strong euro stuff, where the euro appreciates at least until the (small) trade surplus turns to deficit.  This could easily mean 1.50+ vs the dollar (and worse vs the yen) for example. This process at the same time further weakens domestic demand which supports a need for higher member govt deficits just to keep GDP near 0.

So at some point next year I can see deficits that refuse to fall resulting in more demands for austerity, while the strong euro results in demands for ‘monetary easing’ from the ECB.  Of course with what they think is monetary easing actually being monetary tightening (lower rates, bond buying, everything except direct dollar buying, etc.) the fiscal and monetary just works to further support the too strong euro stronger.  

All this gets me back to the idea that the path towards deficit reduction in this hopelessly out of paradigm region keep coming back to the unmentionable PSI/bond tax.  Seems to me we are relentlessly approaching the point where further taxing a decimated population or cutting what remains of public services becomes a whole lot less attractive than taxing the bond holders.  And the process of getting to that point, as in the case of Greece, works to cause all to agree there’s no alternative.  With the far more attractive alternative of proactive increases in deficits that would restore output and employment not even making it into polite discussion, I see the walls closing in around the bond holders, along with the argument over whether the ECB writes down it’s positions back on page 1. And just the mention of PSI in polite company throws a massive wrench (spanner) into the gears.  For example, if bonds go to a discount, they’ll look towards ECB supported buy backs to reduce debt, again, Greek like.  And if prices don’t fall sufficiently, they’ll talk about a forced restructure of one kind or another, all the while arguing about what constitutes default, etc.

The caveats can change the numbers, but seems will just make matters worse.  

The US going full cliff is highly dollar friendly, much like austerity supports the euro.  In fact, the expiration of my FICA cut- the only bipartisan thing Obama has done- which apparently both sides have agreed to let happen, will alone add quite a bit of fiscal drag.  This means less euro appreciation, but also lower US demand for euro zone exports.  So the cliff does nothing good for the euro zone output gap.  

And Japan seems to be targeting the euro zone for exports with it’s euro and dollar buying weakening the yen, as evidenced by Japan’s growing fx reserves (where else can they come from?).

The price of oil could spike, which also makes matters worse.

In general, I don’t see anything good coming out of the current global political leadership.

Please let me know if I’m missing anything!