Thursday, May 14, 2009

European Squabbling Intensifies

Around the 'bearish' minded websites and blogs, dollar bullishness is blasphemy. Those who could even conceive of an outcome other than a hyperinflationary collapse of the US Dollar are commonly referred to as traitors to the ursine religion.

Indeed, how could such a worthless piece of paper backed by the promises of an even more worthless set of bureaucrats possibly hold its value any longer? One answer to that question could be that England succeeded in using split pieces of wood known as "Tally Sticks" as a currency for over 700 years. Another answer could be "for lack of better options." The aforementioned will immediately point to gold as a better option, and I would agree. And I would take that one step further and say that the best option for an alternative to the dollar is whatever people damn well please. That is, we should have a competitive currency system. But until legal tender laws are repealed, that is not going to happen. And legal tender laws will not be repealed until the streets run with the blood of central bankers and the militaries which they command (let's be honest here) who will defend them to the death.

As disturbingly pleasing as that visual image may be, it is not going to happen in the near term. Therefore, we can conclude that the only options to worthless US paper are worthless paper issued by someone else. Exhibit A is the Euro, which coincidently accounts for 57.6% of the Dollar Index. If the Euro rises, the Dollar falls and vice versa. In my opinion, there is no reason to believe that the Euro has any intrinsic characteristics to make it more valuable than the Dollar. And unfortunately for Dollar bears, the Euro has a web of bureaucracy behind it that I believe will eventually lead to its collapse. An article by Bloomberg this morning sums this picture up nicely.

ECB Policy Makers Clash After Trichet Engineers Truce

May 14 (Bloomberg) -- European Central Bank policy makers clashed over the bank’s asset-buying program less than a week after President Jean-Claude Trichet engineered a truce.

Slovenia’s Marko Kranjec said yesterday the ECB is likely to spend more than the 60 billion euros ($82 billion) it has earmarked for covered-bond purchases and hasn’t ruled out acquiring corporate bonds and commercial paper. Hours later Germany’s Axel Weber, who had already said there’s no need to buy other assets, insisted 60 billion euros is the “maximum.” Slovakia’s Ivan Sramko said today nothing can be excluded.

“The ECB Governing Council looks like a battlefield,” said Laurent Bilke, an economist at Nomura International in London. “It would be simply ridiculous if we weren’t already in the middle of the worst recession in postwar history. But now it has more dramatic consequences. Trichet will have to restore some order.”

The diverging views suggest the ECB is still split over the best way to tackle Europe’s worst recession since World War II, even after Trichet said the decisions taken last week by the 22- member Governing Council were “unanimous.” Weber has always opposed asset purchases and warned yesterday against stimulating the economy too much. Other policy makers have argued the bank may need to do more to counter the risk of deflation.

Euro Falls

Currency traders said the prospect of the ECB expanding its asset purchases was weighing on the euro, which fell to $1.3526 today from as high as $1.3721 yesterday.

“The markets have begun to think there’s a possibility the ECB may commit to non-traditional steps,” said Hideki Amikura, deputy general manager of foreign exchange in Tokyo at Nomura Trust and Banking Co. “The euro is likely to be top-heavy.”

Trichet declined to comment on the bank’s plans today after a meeting with French President Nicolas Sarkozy in Paris.

On May 7 Trichet cut the benchmark interest rate to a record-low 1 percent and said that’s not necessarily its lowest level. He also announced the ECB will buy 60 billion euros of covered bonds, securities backed by mortgages and public-sector loans which have suffered a slump in demand during the financial crisis. Details of the plan are to be unveiled next month.

“The 60 billion euros they announced is peanuts for an economy the size of the euro zone,” economics professor and former Bank of England policy maker Willem Buiter said at a conference in Dublin yesterday. “I expect they will announce more or that the recession in the euro zone will be longer and deeper than would otherwise be necessary.”

Quantitative Easing

The Federal Reserve, Bank of England and Bank of Japan have lowered their key rates to close to zero and are buying government and corporate debt, effectively pumping new money into their economies to prevent the development of a deflationary spiral.

The economy of the 16 euro nations will contract 4.2 percent this year, according to the International Monetary Fund. Recent reports suggest the recession may be bottoming out.

Trichet was forced to compromise on the ECB’s asset- purchase program in order to get Weber on board. Weber argues Europe isn’t at risk of deflation and the ECB should avoid taking additional risk onto its balance sheet. He also wants the ECB to signal an end to rate cuts.

Other council members say the ECB can do more. Athanasios Orphanides, the former Fed economist who now heads the Cypriot central bank, has said the ECB may have to continue easing policy if deflation risks increase.

Final Amount?

Kranjec, who heads the Bank of Slovenia, said in an interview in Ljubljana yesterday that the ECB can lower rates further if needed and 60 billion euros is “not the final amount” for the asset-purchase program. The bank has not ruled out buying corporate bonds or commercial paper, he said.

Sramko said at a conference in Vienna today that the ECB “can exclude nothing” on non-standard measures. “I’m sure the council will also discuss other possibilities,” he said.

Still, Marc Chandler, head of global currency strategy at Brown Brothers Harriman in New York, said that as president of Germany’s Bundesbank Weber has considerable influence.

His views “probably reflect the attitude of most of the other participants,” he said. “Who’s going to agree with the guy from Slovenia against Weber?”

Austria’s Ewald Nowotny said today the ECB has decided to buy covered bonds and “that’s it. No further options are of relevance now.”

‘Powerful Comeback’

Weber said in a speech in London last night that inflation may make a “rapid and powerful comeback” if the economy recovers faster than expected and policy isn’t tightened as quickly as it was loosened.

ECB Vice President Lucas Papademos agreed, saying there are signs the economy is stabilizing and “the recovery may start sooner than previously envisaged.”

“Once financial conditions and the macroeconomic environment improve, the non-standard monetary policy measures taken should be quickly unwound,” Papademos said in Vienna.

At the same conference, Dutch council member Nout Wellink contradicted Papademos on the economy, saying it’s best not to “become too optimistic when you see a few swallows flying around or green shoots.”

Turning to asset purchases, Wellink said: “The council has made it’s decision and that’s it for the time being. There is a need under the present circumstance, with so much uncertainty around, to be clear. There is a need for a precise clear-cut message. We have given such a message.”

Wellink insists that the ECB has given a clear message. The message I got was that these folks probably couldn't agree on what to order for breakfast let alone monetary policy.

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Occdude said...

There is a seismic shift going on in the global economy which factors into the anti-deflationary argument.

Emmerging markets don't have the developed credit markets that the G7 have so their deflationary pressures in comparison to ours are minimal and therefore they will come out of this sooner than us, if they try to inflate they will get a Zimbabwe in fact they don't even need to inflate because we're gonna do it for them.

All it's going to take is two things for a new world order. A new global currency limited in quantity by hard assets in addition to a basket of currencies and a re-tooling of the manufactoring base to trade with other countries who actually make things that the other country needs, this is how you raise living standards, remember you should be exporting so that you can import.

The Chinese are vigorously pursuing purchases of oil, iron ore, gold and other commodities both steathily and in great quantities to arbitrage their dollar positions. Also,they are limiting their exposure on our long term debt, preferring the shorter end of the curve.

The Chinese having the Japanese as an example aren't eager to replicate their mistakes. In the eighties the Japanese hit a wall. All their dollars it turned out, couldn't be converted to things that they actually could use. They made us goods but we didn't have anything they wanted. So, in an attempt to avoid the necessary liquidation and realignement of their economy to actually TRADE the Japanese went speculating in American and domestic real estate along with American companies purchased for inflated prices. Well you can see the result of that practice, a nearly frozen economy since that time. In fact pictures of Japan resemble how I saw Japan personally in 1987, their stuck in a time warp.

The Chinese attempt to "spiffy up" their economy is a prelude to challenge the dollars dominance as a mechanism for global trade settlements. The Chinese want foriegn currency reserve status. With their large amounts of accumulated savings they can affect a change in the manufactoring base and trade finished goods for both raw matierials and high end quality goods produced by some of the Europeans and the Japanese. They are cleaning house and are readying themselves to step into the void with a stable currency that is not going to inflate like the dollar will and be backed by actual purchasing power, whereas the dollar will continue to be debased.

If the dollar wasn't going to be diluted, it would be a very satisfactory currency DESPITE our economic condition as you pointed out with your stick analogy, anything can be used as currency as long as the supply of currency is regulated by some mechanism.

Right now the mechanism is Americans political desire for a free lunch and we have an unquenchable hunger, so it will need to be replaced, otherwise all the countries (and individuals) who lash their boats to the dollar are gonna get sunk.

In short, the Europeans are in no position to surplant the dollar with the Euro. The Chinese however are laying the groundwork. And with infinite patience and strategic thinking could capture the brass ring which is the worlds reserve status along with all the prestige that entails. The Chinese are that audacious and ambitious despite outwardly appearing humble and conforming, they are a smart people and playing chess while we're playing checkers.

Occdude said...

Look Matt, someone who agrees with me.

occdude said...

And lastly a little comic relief.

"The federal government is sending each of us a $600 rebate.
If we spend that money at Wal-Mart, the money goes to China.
If we spend it on gasoline it goes to the Arabs.
If we buy a computer it will go to India.
If we purchase fruit and vegetables it will go to Mexico, Honduras and Guatemala.
If we purchase a good car it will go to Germany.
If we purchase useless crap it will go to Taiwan
and none of it will help the American economy.
The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in US. I've been doing my part."
Marc Faber

Matt Stiles said...


I'm aware of all the potentialities. And I'm aware of all the smart folks who disagree with me. Roubini and Faber are just the tip of the iceberg. Everything they say "makes sense" because their economic models all say that if one increases the money supply you end up with inflation.

Keep in mind that China, while appearing old and wise (playing chess, while we play checkers) is still a centrally planned state. Centrally planned states do not work. Also keep in mind that amid all of the talk of China supplanting the US in everything from military power to the reserve currency, they are still a fraction of the size. Even their reserves of $2T are overplayed in my opinion. $2T is not all that much - certainly not enough to take over the world as is often suggested.

I study social and generational cycles (see links to the side of my page) as well as Austrian economics which focuses on the time preferences of individuals. All suggest with impressive historical accuracy that what we are experiencing now is "the big one." Previous big ones (or "crisis eras") in major economies have all been deflationary. Inflations and the destruction of many currencies tend to happen in "awakening eras" when populations are growing and land/resources are becoming scarcer.

It is a romantic idea. To think that such a broken system will all of a sudden disappear and be replaced with something better - even if it comes from an "enemy." It's what "should" happen.

I don't see it happening. At least not in the next decade or two.

RRB said...

Matt - does that then mean Obama can continue spending/ borrowing/ monetising debt with impunity? How can it be sustainable? Or are we looking at asset price deflation and commodity price inflation?

Matt Stiles said...


Government spending is no substitute for private investment. They simply cannot do it in an efficient manner. Think about the destabilizing effect sudden government competition has on the private sector. Government wanted to get into the auto business. Now it appears that their influence is causing rivets in the securitized debt markets, thus making it harder for solvent firms to raise capital. Central planners believe that spending is spending. They see a correlation between spending and growth and therefore conclude that if spending is lower than they think it should be they can simply do it themselves. It doesn't work that way.

Additionally, think of the increasing debt servicing obligations that are being incurred in an environment (debt deflation) when it should be falling. That puts unnecessary strain on the ability for individuals or businesses to invest.

Literally every move the Obama Administration should "theoretically" cause positive inflation. But the theory is bunk. So it won't work. The market will do what it wants and has to do. Asset prices must fall. So they will...

Roger Jarema said...


Nice takes there on China. So, while at it let's continue the discussion. I think China has a lot of hidden & interesting stories that many pundits fail to even give a slight glance.

Due to their centrally planned economics, they can do what the US can't:
1. they can force banks to lend (because most of their banks are state-owned)
2. they can force businesses to borrow (because the big ones are SOEs)

I guess that's why early in the year until recently, we had the news of China lending boom. Of course, the problem is/will be a moonshot of NPLs on the already astronomical NPL.

China has chronic NPL problem. In 2006 its NPL was 40% their GDP. They keep hiding it using AMCs.

There are already numerous rightful warnings about this... and that this can eventually collapse China. But it never, or I should say... has not materialized.
One example of that is this 2005 article:

With these problems, many experts are still saying that RMB will rise dramatically (by 30-40%) if China is not manipulating it. But God forbid... could the exact opposite be the truth? Mish and Frank Shostak seem to share this view:

So, what's your take on this? Do you also view that absent of manipulation RMB will actually crash against USD?

RRB said...

Matt - thanks for your feedback, but maybe I didn't make my question clear: what are the implications, according to you, of the massive debt burden being built by Obama? What impact, if any, do you anticipate on the dollar? Is there anything that can slow down this massive build up of debt? How is the US likely to react to its likely future inability to service its debt?

I assure you that you are preaching to the choir about the distortions govt spending creates in the marketplace.

Occdude said...

Matt there are smart guys on both sides of the aisle here, which is the distressing part. So far the inflation is working because if they hadn't injected all that money and credit into the system it most definitely would have crashed. So inflation does work, but only in amounts greater than deflation. Stage two will be even more expansive with the government getting personally involved with the operations of the economy. The problem isn't with the Federal government which operates under public scrutiny, but with FED which operates as a protected monopoly

I think that both sides are going to have their cyclic victories. You address a key point of contention between the two factions though and that is the suitability of the dollar as a refuge from economic crisis. There we part paths, because dilution is dilution and the insidiuos parts of inflation are not very well understood or appreciated. They can manifest as consumer price inflation and as asset price deflation or vice versa. It can reinforce bad behavior to the point of ruination.

As far as China goes, they are no joke even with a paltry 2trillion, they have already established productive capital on the ground and what I call the "X" factor amalgam of personal spending habits, hard working, intelligent people and juvenile credit markets. As far as central planning goes I agree with you wholeheartedly however, we are the new centrally planned economy and are becoming more so by the week. Whilst, the Chinese are becoming less so. The Chinese main problem right now (besides exiting the dollar) is reallocating productive capital. Thats it, they have to find other people who want their stuff and who can pay. That pales in comparison to our problems of crushing debt, probably 20 plus years of malinvestment and a gutted manufactoring sector with no capital to rebuild. Look how quickely we turned our manufactoring capacity of WW2 into standard of living improvements. We had a severe post war recession, but with high savings rates and the manufactoring base we developed, we turned around quickly.

I believe your picking up on the right signals that this is the "big one" but it's not going to play out the way you think with everyone getting flushed down the toilet at the same time for the same reasons. This is a power center change from one former power into a new emergent one. I as an American don't like that fact, but being honest I can't deny it either.

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