All Eyes on Europe (or was that Seoul?)

By Claus Vistesen, on November 15th, 2010

Life can be incredibly cruel sometimes. Only a week after Bernanke gave markets an early Christmas present with another helicopter drop the SP500 is stuttering and it seems, much as many astute observers have argued, that the real effect from QE lies in the announcement itself. Further, and to add insult to injury a recent survey conducted by Bloomberg suggests that the Fed’s reenactment of QE is not particularly popular among investors as they don’t think it will help the economy or the unemployment rate but rather that it is a deliberate policy to drive down the USD.

Ok, this is the trivial point then and I don’t give much for the investors’ opinion here since one presumes these are the same investors that recently scurried around the QE2 announcement as, well, pigs around the trough. The real irony here is that just as Bernanke thinks he can settle down to watch the USD drift down to help exports the crisis in the Eurozone flares up again, pushing a correction in the Euro and a general sentiment towards risk-off which would be positive for the USD. So, if QE does not help the economy or the unemployment rate and can’t even push the USD down and/or secure a decent melt-up in risky assets, what is a poor central banker left to do?

Now, my screen is a sea of red today which may provide the first bid for an answer for that question and the reason is essentially that the great eye of the market has turned from Bernanke’s helicoptor drop to the Eurozone where the problems of course never went away (oh and of course tightening in China). To add further context, provisional GDP estimates suggest that growth has slowed down notably in the Eurozone with especially the peripheral economies such as Spain, Italy, Ireland posting anemic growth rates.

In itself, it is not surprising that the effect from QE2 has gone astray, but the ultimate cynic would no doubt point to the fact that the real catalyst of the resurgence of the market’s focus on problems in the Eurozone coincided pretty well comments from first Angela Merkel and second the French finance minister Lagarde that bondholders should ultimately prepare for taking a loss on peripheral bonds.

Effectively, this seems to have broken Ireland’s back and now it is only a matter of time before Ireland enters into some form of quasi IMF/EU custody and most likely we will see just what kind of beast the stability fund is. Of course, the actual degree to which bondholders are supposed to take part in a restructuring was greatly watered down by comments hitting the wire today that outstanding debt would not be affected.

(quote Bloomberg)

European finance ministers said plans to establish a new crisis resolution mechanism, including the potential for bondholders to be held accountable, will not apply to outstanding debt. “Any new mechanism would only come into effect after mid-2013 with no impact whatsoever on the current arrangements,” the finance ministers of Germany, France, Italy, Spain and the U.K. said in a statement distributed to reporters in Seoul today.

This sounds to me to be the ultimate rubber paragraph and won’t do anything but to kick the proverbial can down the road, but in terms of calming markets in the here and now. Perhaps. On Ireland in general, I have already covered the situation in some detail, but going back to the cynical take on this situation, it seems that Ireland might have been thrown to the wolves exactly in order to bring a little attention back on Europe and thus in an attempt to avoid that the EURUSD moved too much above 1.40. It certainly seem to have worked.

Perhaps this is me being too cynical however and surely the toolbox contains other tools than merely pulling the restructuring and pissing off everyone. One alternative is that the ECB joins the ranks of its QE wielding colleagues in Japan and the US and start buying them bonds, big time and with no reservations and questions asked. Indeed, Bloomberg’s Simon Kennedy and James Hertling said it well when they recently denoted the ECB not only as the buyer of last resort, but of only resort;

(quote Bloomberg)

European Central Bank President Jean-Claude Trichet is the buyer of only resort as the euro area’s bond market melts down (…) ”The ECB’s lack of action is puzzling to say the least and begs the question as to whether it’s fulfilling its financial- stability mandate,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland in London. “The more the ECB waits, the bigger the purchase program will have to be.”

Note in particular monsieur Cailloux’ comments here. Basically, he is saying. What the heck are they waiting for?

A likely question can be directed at the G20 who concluded their meeting this week in Seoul and while I certainly recognise the inherent difficulties in agreeing on difficult issues, it is a bit disappointing still. Macro Man provides a cynical view of the consequences of s strong global consensus of doing nothing. Perhaps, this is part of the effect from markets seemingly being able to eye only one thing at once?



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The Folly of Risking Trade War

By Emmanuel Tabones, on November 15th, 2010

There is a scene in Book XXI, Chapter IV, of Sir Thomas Mallory’s Le Morte D’Arthur,” which described how King Arthur waged his final battle with Sir Mordred, concluding with the utter destruction of both their armies, and leaving the latter surviving, alone. Meanwhile, the monarch still had two knights left, Sir Lucan and Sir Bedivere, though they were both “sorely wounded.” Sir Lucan pleaded with the king not to continue the conflict any further, reminding him that he had “won the field” that day. But Arthur would have none of that as he was determined to exact final revenge, at whatever cost. Readers all know what happened next because of his fateful decision.

This all came to mind as I read a recent question posted in the Wall Street Journal’s online “Journal Community” section:

Should the U.S. and other countries risk a trade war with China over the valuation of the yuan?

Alas, it is just another way of saying, should the U.S. and like-minded countries risk mutually assured destruction in order to fix what others refer to as a non-existent problem, or at worst, one that is overblown.  We could all simply end up like King Arthur.

As economist Walter E. Williams noted in his excellent article entitled, “Our Trade Deficit (May 25, 2005):” “I buy more from my grocer than he buys from me, and I bet it’s the same with you and your grocer. That means we have a trade deficit with our grocers. Does our perpetual grocer trade deficit portend doom?”

Of course not, I say, but as Dr. Williams had observed, this example illustrates that there is more to the issue than those seemingly frightening deficit figures used by certain “pundits and politicians” to scare the general public, and there are a fair number of such fear mongers these days, both from the political right and left, whether we refer to Pat Buchanan, Lou Dobbs, as well as former congressman Richard Gephardt, current U.S. Senator Sherrod Brown (D-Ohio), and a host of others.

However, judging from the lopsided poll results and angry posts in support of trade war, these respondents and other, similarly outraged individuals, have largely ignored the thoughtful and sensible pronouncements of people like Dr. Williams. Yes, these folks have certainly worked themselves up to a similar, “to hell with the consequences” frenzy, and the U.S. Federal Reserve’s new  initiative, known as QE2, is largely influenced by these same views. Fortunately, saner heads seem have to have prevailed at the recent G20 summit, with the general consensus rejecting American efforts to pressure China to relax tight controls on its currency. Yet, that hardly resolved any major issues, leaving the prospect of trade war hanging over everyone’s heads like a dreaded “Sword of Damocles.” More importantly, the United States has simply incurred the opposition of trading partners such as Germany (not to mention China) for this seemingly reckless monetary policy aimed at further bringing down the value of the U.S. currency, all in the name of “stimulating the U.S. economy and creating jobs.”

Gee, if only things were that simple and not fraught with risks, such as the likelihood of causing a dramatic rise in inflation, especially in the price of commodities like petroleum products. With the continued deterioration of the U.S. dollar, we may very well see oil prices again rise north of USD $100 per barrel, perhaps as early as 2011.  The Obama administration is probably betting that many Americans (especially those who actively participate as voters) are not savvy enough to know the connection, and unfortunately, that may very well be the case. Maybe people will finally figure it out once oil hits USD $200, with inflation raging at 20 percent.

Meanwhile, I doubt President Obama fooled anyone with his insistence that QE2 was “not meant to deliberately weaken the U.S. dollar,” as reported by Ben Feller of AP and others. It also appeared that the Fed was not fully prepared for international reaction, especially with countries getting ready to, or having imposed additional financial regulations meant to blunt the intended effects of QE2. Nowadays, I am increasingly convinced that Bernanke and his people are losing their grip on economic, global reality.

With this unfortunate and largely misleading political perception that America’s high unemployment rate is directly linked to its massive U.S. trade imbalance, and with increasing demands to impose trade barriers, other nations could likely respond in kind, which could bring us to a SH2 (Smoot-Hawley 2) type scenario and an economic nightmare that could reduce global trade dramatically and bring about massive, worldwide unemployment not seen since the Great Depression. As the philosopher George Santayana was quoted as saying, “Those who do not learn from history, are doomed to repeat it.”



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Economic Events on November 15, 2010

By B.P.T., on November 15th, 2010

At 8:30 AM EDT, the Empire State manufacturing index for November will be released.  The consensus is that the index value will be 15, which would be an decrease of 0.73 points from October, after an increase of over 11 points last month as economic indicators improve in New York.

Also at 8:30 AM EDT, the Retail Sales report for October will be released.  The consensus is that retail sales increased 0.7% from September, after a 0.6% increase last month.

At 10:00 AM EDT, the Business Inventories report for September will be released.  The consensus is that inventories increased 0.9% from August.

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