Category Archives: EU

thoughts on the euro

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So my story has been that while most thought QE was a bumper crop for the dollar- Fed printing money and flooding the system with liquidity and all that-

It was in fact a crop failure for the dollar, as evidenced by the Fed turning over $79 billion in QE profits (that would have otherwise gone to the economy) to the Tsy.

And because everyone thought it was a bumper crop, they all sold the heck out of dollars in all kinds of theaters and iterations, from outright selling of dollars, to buying of commodities and stocks and in general making all kinds of dollar ‘inflation bets.’

And then a few weeks ago Chairman Bernanke comes on tv and starts talking about how his policies are strong dollar policies, just as the dollar index hit its lows and within a day or so headed north.

At the time it seemed strange to me that he’d suddenly, out of nowhere, break silence on the dollar and make those kinds of strong dollar statements previously left to Treasury. Unless he had a pretty good idea the dollar would start going up.

And only a few days ago he again spoke about how his policies were strong dollar policies, and the dollar traded around a bit, but remained above the lows and then headed back up. Especially vs the euro.

And shortly after that we find out China had let maybe $200 billion in T bills run off since QE2 started, and while their dollar holdings didn’t fall, their reserve growth was allocated elsewhere, and, from market action, there were substantial allocations to the euro. This hunch was further supported by their earlier announcement that they would be buying Spanish bonds to ‘help them out’ as a Trojan horse to buy euro to support their exports to the euro zone.

So my story is maybe the T bill runoff thing was a shot across the Fed’s bow? China was in the news objecting to QE and demanding what they considered ‘sound money’ policy. So it would make sense, to let the Fed know they were serious, to do something like let their T bills run off and alter fx allocation ratios away from the dollar and toward the euro, all of which caused the dollar to sell off for several months. And with the implication, and maybe also in private conversation, that any more QE would mean outright selling of dollar reserves. And the Fed Chairman taking this to heart and with other FOMC members also objecting to more QE, and maybe even knowing that QE doesn’t do anything anyway apart from scaring global portfolio managers, including those in China and Russia, etc. out of dollars, maybe somehow reached an understanding with China, where China would return to ‘normal’ fx allocations and there would be no QE3? And the subsequent strong dollar speeches that followed had the knowledge behind them that China had returned to dollar financial asset accumulation, which would likely end the dollar slide and reverse it?

This also means the euro has lost this ‘extra’ support it’s ‘enjoyed’ for the prior several months, which means it’s all a lot worse for the euro than it is good for the dollar, as they have bigger fish to get deep fried than just the level of the currency. Seems the last thing they need now is for a major buyer of euro denominated debt to switch allocations to dollars.

And it also could be that this ‘extra’ euro debt buying has been delaying the euro crisis for the last several months as well. This means it’s all been propped up while getting worse down deep, which means if that support has now been pulled, it falls that much harder.

A lower euro also works to ‘inflate away’ euro zone national govt debt ratios, and currency depreciation in general as a market induced path to debt relief is a well known phenomena, though one the ECB is likely to fight to comply with its low inflation mandate. And fighting inflation means hiking interest rates, which, while initially helping some, actually work to increase national govt deficits and hurt their credit ratings, as well as further depress the euro.

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The people have spoken in Portugal

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As previously discussed, it’s not obvious to voters that the currency itself is the problem.

Instead, what seems obvious is that the prior governments were at fault for their irresponsible fiscal policies for which the price is now being paid.

Coelho Told by Portugal’s Cavaco to Hurry Coalition Talks

By Joao Lima

June 7 (Bloomberg) — Pedro Passos Coelho, Portugal’s incoming prime minister, was told by President Anibal Cavaco Silva to start talks immediately on forging a coalition to ensure austerity measures mandated by a 78 billion-euro ($114 billion) bailout stay on track.

The order that Coelho move came in their meeting yesterday in Lisbon less than 24 hours after the Social Democrat unseated Socialist Jose Socrates, Jose Manuel Nunes Liberato, a presidential aide, told reporters.

Starting talks with the People’s Party before all the results are in underscores officials’ concerns over meeting deadlines prescribed in the bailout. Leaders of the third-place finishers meet today in Lisbon and may signal their demands to join as Coelho’s junior partner.

“There is a majority government and that is a necessary condition to implement the very difficult structural reforms and the challenging fiscal consolidation,” Antonio Garcia Pascual, chief southern European economist at Barclays Capital in London, said yesterday.

Coelho’s Social Democrats and the People’s Party, won a combined 129 seats in the 230-member parliament with four seats yet to be decided, according to official results.

While all three major parties committed to the bailout’s program of spending cuts and asset sales, a new majority taking over from Socrates’ minority administration gave bonds a boost. Yields on 10-year notes rose 8 basis points to 9.372 percent in Lisbon as of 10:16 a.m. today.

Opposition wins Portugal election. Portugal’s right-of-center Social Democrats have the dubious privilege of imposing massive budget cuts and risk further exacerbating the country’s economic woes after winning yesterday’s election with around 40% of the vote. The Social Democrats will probably form a coalition with the conservative Popular Party and so gain a majority in parliament. This will make it easier to implement austerity measures, such as welfare and pay cuts, and tax rises, as the government looks to comply with the terms of a €78B ($114B) bailout. The coalition takes office with unemployment at a record 12.6% and with the economy forecast to contract 4% over the next two years.

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the euro zone in transition

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As previously discussed since inception, operationally the euro zone, much like every other nation with its own currency, will, one way or another, wind up with the ECB, the issuer of the currency,
‘funding’ fiscal deficits sufficient to meet any net savings desires in that currency, as well as funding the banking system’s liabilities.

The open question has always been is how it gets from here to there, and the answer to that has never been clear.

So far it’s doing it with great reluctance, with the ECB funding the banking system and select national govts only as a last resort, and not yet in the normal course of business.

A weakening global economy now seems to be forcing the next move towards the ultimate expected outcome.

We may have reached that point where their austerity measures, rather than bringing national govt deficits down, will instead make those deficit go up, as they induce macro economic weakness which ‘automatically’ increases transfer payments and decreases tax revenues.

This is a highly unstable equilibrium condition that can accelerate into a variety of forms of oblivion, which ultimately reaches the core as default risk premiums move down the line, much like a multi car pile up as one car after another crashes into the lead pack of wrecked cars.

And as the core is threatened, holders of euro financial assets, including foreign govts that hold various forms of euro financial assets as foreign currency reserves, feel the walls closing in, as one credit after another falls by the wayside.

Only a sudden increase in world aggregate demand, or a sudden change of policy that includes pro active ECB funding, is likely to be able to reverse what’s been happening

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German Exports Surged to Record in March, Boosting Growth

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“The German government predicts economic growth of 2.6 percent this year after a record 3.6 percent expansion in 2010. The country will regain its place as the world’s second- biggest goods exporter in 2011 after being overtaken by the U.S.”

Interesting perspective.

3.6% is pretty low for a record year, and this year looks to be lower than last even with ‘booming exports’

It’s all a sign of low aggregate demand, particularly with the growth of 0 marginal cost infinite leverage output such as software, music, and video which is simply downloaded. There is no ‘speed limit’ for that kind of thing, so directed accordingly, non inflationary GDP can grow at any rate.

German Exports Surged to Record in March, Boosting Growth

By Jana Randow

May 9 (Bloomberg) — German exports surged in March to the highest monthly value ever recorded, boosting growth in Europe’s largest economy.

Exports, adjusted for work days and seasonal changes, jumped 7.3 percent from February, when they gained 2.8 percent, the Federal Statistics Office in Wiesbaden said today. Economists had forecast a 1.1 percent increase, according to the median of 10 estimates in a Bloomberg News survey. Exports were worth 98.3 billion euros ($141.4 billion) in March, the most since records began in 1950, the statistics office said.

Germany’s economic recovery is broadening as companies boost investment and hiring to meet booming export demand from emerging Asia. The economy may have expanded as much as 1 percent in the first three months of the year and may maintain its growth momentum in the current quarter, according to the Bundesbank.

“The German economy continues to power ahead,” said Holger Schmieding, chief economist at Berenberg Bank in London. “After a very strong start to 2011, Germany may lose a little steam over the summer.”

The euro rose almost half a cent after the report to $1.4424 at 8:16 a.m. in Frankfurt.

Record Imports

From a year earlier, exports rose 15.8 percent, today’s report showed. Imports advanced 16.9 percent in the year and 3.1 percent from February. Worth 79.4 billion euros in March, imports also reached a record monthly value.

The trade balance widened to 18.9 billion euros from 11.9 billion euros in February. The surplus in the current account, a measure of all trade including services, was 19.5 billion euros in March, up from 8.7 billion euros in February.

Germany’s BASF SE, the world’s biggest chemical company, reported a 40 percent jump in first-quarter earnings last week and Siemens AG, Europe’s largest engineering company, said profit this year will rise at least 75 percent.

The German government predicts economic growth of 2.6 percent this year after a record 3.6 percent expansion in 2010.

The country will regain its place as the world’s second- biggest goods exporter in 2011 after being overtaken by the U.S. last year due to exchange-rate movements, the Ifo economic institute said on April 19.

“In times of investment catching up in the emerging world, infrastructure renewals in the western world and a general shift of energy policies toward alternative and renewable energies, German industry simply offers the right mix,” said Carsten Brzeski, senior economist at ING Group in Brussels.

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ECB debt buying plan suffers fresh setback

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ECB debt buying plan suffers fresh setback

Another silly headline that completely misses the point of monetary operations.

The ‘debt buying plan’ is a purely technical move to do what is called ‘offset operating factors’ as a means to hitting the ECB’s interest rate targets.

The quantity of securities offered to do this is entirely inconsequential. As always, for a central bank, the monopoly supplier of net reserves for its currency of issue, it’s about price (interest rates) and not quantities. And the only possible ‘inflationary impact’ is via the interest rate channels:

(FT) — The European Central Bank faced embarrassment on Tuesday after failing for a second consecutive week to neutralise fully the inflationary impact of funds it had spent buying government bonds to combat the region’s debt crisis. On Tuesday, the ECB was due to reabsorb €76bn – the total amount spent under the bond-buying programme so far. But banks only offered €62bn. Last week, the ECB had also failed to reabsorb the required amount. In total, such operations have failed five times in the past year.

The latest setback was the result of higher market interest rates, which deterred banks from parking funds at the ECB. It could fuel ECB nervousness about its bond buying.

Europe Services, Manufacturing Growth Accelerated in April

(Bloomberg) — European services and manufacturing growth accelerated in April. A composite index based on a survey of euro-area purchasing managers in both industries rose to 57.8 from 57.6 in March, Markit Economics said. That’s in line with an initial estimate on April 19.

They call the above an acceleration, I suppose because it fell in March:

The euro-area services indicator fell to 56.7 from 57.2 in March, Markit said, below a preliminary reading of 56.9 released last month. The manufacturing gauge increased to 58 from 57.5. In Germany, which has fueled the region’s recovery, a manufacturing indicator rose to 62 from 60.9 in March, while a services gauge slipped to 56.8 from 60.1.

Europe Retail Sales Decline Most in Almost a Year on Oil

Note the ‘and government austerity measures’ didn’t make the headline:

(Bloomberg) — European retail sales declined the most in almost a year in March as higher oil prices and government austerity measures curbed consumer spending. Sales in the 17-nation euro region fell 1 percent from the previous month after a revised 0.3 percent increase in February. March sales dropped 1.7 percent from a year earlier. Among services companies, “expectations for their activity levels in 12 months’ time slipped for the second successive month to reach a six-month low,” Markit said in a report. German retail sales declined 2.1 percent in March from February, when they fell 0.4 percent, today’s Eurostat report showed. In France, sales dropped 1 percent. Spanish sales fell 1.4 percent, while Ireland saw a 0.6 percent increase.

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Euro Approaches 18-Month High Versus Dollar Before ECB Decision

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Interesting how portfolio managers and speculators- the herd in general- clings to long dispelled theories.

Note the large shift away from the dollar and into commodities on QE2, which in fact did nothing of consequence apart from turning psychology.

And the idea that rate hikes support a currency has been long dispelled by extensive research, including decades of central bank research.

Euro Approaches 18-Month High Versus Dollar Before ECB Decision

By Lucy Meakin

May 4 (Bloomberg) — The euro rose against the dollar, approaching its strongest in 18 months, on speculation that European Central Bank PresidentJean-Claude Trichet will signal further rate increases after policy makers meet tomorrow.

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more on ECB funding dependence in the eurozone

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Yet another substantiation of just how much the entire system is (necessarily) dependent on ECB funding/backstopping.

The ECB’s Secret Bailout Strategy

By: Hans-Werner Sinn

Excerpt:
The amount of the ECB’s “replacement lending” is shown by the so-called Target2 account, which measures the deficit or surplus of a country’s financial transactions with other countries. As the account includes international payments for both trade in goods and financial claims, a deficit in a country’s Target account indicates foreign borrowing via the ECB, whereas a surplus denotes foreign lending via the ECB.

The balance is not reported on the ECB’s balance sheet, since it is zero in the aggregate, but it does show up on the respective balance sheets of the national central banks as interest-bearing claims against, and liabilities to, the ECB system. Until mid-2007, the Target accounts were close to zero, but since then, they have grown by about €100 billion per year.

For example, the Bundesbank’s Target claims ballooned from €5 billion in 2006 to €323 billion by March 2011. The counterpart to these claims were the PIGS’ liabilities, which had grown to about €340 billion by the end of last year. Interestingly, the PIGS’ cumulative current-account deficits from 2008 through 2010 were of roughly the same order of magnitude – €365 billion, to be precise.

Had the ECB failed to finance these deficits, the PIGS would have had a hard time finding the money to pay for their net imports. If they succeeded at all, high interest rates would have induced them to tighten their belts, and their current-account deficits, which in the case of Greece and Portugal exceeded 10% of GDP, would have diminished.

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More on the euro zone deficit report

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Yes, the deficit went from 6.3% to 6% of GDP, but the question remains as to whether they are at the point where further slowing from austerity measures continue to reduce the overall deficit or, instead, an induced slowdown begins to increase it.

Euro Zone 2010 Deficit Shrinks, Debt Rises

April 26 (Reuters) — The euro zone’s aggregated budget deficit fell last year as most countries slashed government spending to restore market confidence in public finances, but the debt still grew, Eurostat data showed.

The European Union’s statistics office said on Tuesday the budget deficit in the euro zone in 2010 was 6.0 percent of gross domestic product, down from 6.3 percent in 2009. Public debt, however, rose to 85.1 percent from 79.3 percent in 2009.

All euro zone countries except Germany, Ireland, Luxembourg and Austria improved their budget balance last year, but debt rose in all euro zone countries except Estonia.

Eurostat said Greece, which was forced to seek emergency funding from the euro zone last year because it was effectively cut off from market borrowing due to its large debt, cut its budget gap to 10.5 percent of GDP from 15.4 percent in 2009.

This is well above the initial target of the Greek austerity programme of 8 percent and even above the latest estimate from the European Union and the International Monetary Fund of 9.6 percent.

Greek public debt rocketed to 142.8 percent of GDP from 127.1 percent in 2009.

Ireland saw its budget deficit more than double to 32.4 percent of GDP last year from 14.3 percent in 2009 and its debt jumped to 96.2 percent from 65.6 percent as the country had to borrow to bail out its banking sector.

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Euro-Area Debt Reaches Record 85.1% of GDP as Crisis Festers

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It’s hard to say from the headlines whether proactive deficit reduction measures are slowing the economies to the point where the slowing is causing their deficits to increase.

However, if that is the case, continuing their deficit reduction efforts will only make things worse, to the point of forcing social upheaval.

And the rising deficits will begin to weaken the euro, as the deficit reduction that initially worked to strengthen the euro reverse.

And higher rates from the ECB will only serve to further increase national government deficits via higher interest payments by those same governments.

This also makes euro ‘easier to get’ and thereby weakens the currency.

Yes, the euro zone is seeing ‘inflation’, as they define it, moving higher, but under current conditions I don’t see any channel from rate hikes to lower ‘inflation’, again as they define it. But I do see how higher rates can instead add to the general price level through income interest and cost channels. All of which would be exacerbated should this policy also cause the euro to depreciate.

With regards to funding, there is nothing operationally to stop the ECB from, for all practical purposes, funding/backstopping the entire banking system as well as the national governments.

The question is the political will, which is not quantifiable.

And the solution remains painfully simple- the ECB can simply announce an annual payment of 10% of the euro zone’s gdp to the national governments on a per capita basis.

This will have no effect on inflation as it won’t get spent. It will only serve to allow all of the national governments to borrow at the ECB’s target rate, which would lower funding costs for the nations currently paying premiums for funding.

This will also give the ECB a lever to control deficits- the threat of suspending a nation’s funding if it is not in compliance.

And by removing the threat of market discipline from funding, the region would be free to set their stability and growth pact deficit targets at levels designed to achieve their macro economic goals for employment, output, and price stability.

Euro-Area Debt Reaches Record 85.1% of GDP as Crisis Festers

(Bloomberg) Euro-area debt reached a record in 2010. Debt rose in all 16 countries that were using the euro last year, lifting the bloc’s average to 85.1 percent of gross domestic product from 79.3 percent in 2009, the European Union’s statistics office said. Greece’s deficit topped expectations and debt ballooned to 142.8 percent of GDP, the highest in the euro’s 12-year history. Ireland’s debt surged the most, by 30.6 percentage points to 96.2 percent of GDP. Contingent liabilities from guaranteeing the banking system after the 2008 financial panic now amount to 6.5 percent of GDP, down from 8.6 percent in 2009, Eurostat said.

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