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Thursday January 17, 2008 - 13:52:47 GMT
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Google: A Technical Indicator for the EMU flawed experiment!

FX Trading – Google: A Technical Indicator for the EMU flawed experiment!

This morning I did a Google search for two words, first ‘Bernanke’ and then ‘Trichet’. The Federal Reserve chairman’s namesake returned 3.25 million results. The European Central Bank president returned only 1.4 million.

A beleaguered dollar, surging commodity prices and a struggling economy have made Mr. Bernanke quite popular. As a living and acting symbol of the Federal Reserve, Ben Bernanke has been the subject of numerous articles that touch upon the outlook for the U.S. economy.

Certainly Bernanke feels the pressure every day. Now my question is: Are we going to see the Google search numbers for Trichet start to increase?

An article citing remarks from one of Trichet’s colleagues at the ECB casts shadows on the European economy. The potential for a Eurozone downturn tugs at the shirt of the ECB head hauncho and puts his interest rate policy in question.  But our concern goes beyond ECB interest rate policy.  It goes to the heart of EMU as a viable framework.

We have long wondered what would happen to the euro when it finally faced a real test, i.e. a downswing in the business cycle. Such a test could now be underway. 

Below is an excerpt from historian Niall Ferguson’s most excellent book entitled, “The Cash Nexus: Money and Power in the Modern World 1700-2000.”  The book was written published in 2001.  We believe Mr. Ferguson’s extremely poignant analysis of the European Monetary Union, it inherent flaws and the ECB role are particularly timely now as the key dollar alternative, the illustrious euro, faces its first true down-cycle test, and that most of the focus is on US problems [our emphasis added]:

“Time and again in history…a leap in inflation has been the line of least resistance for governments in fiscal difficulties: the defeated powers after the First World War, for example, or Russia and the Ukraine since the collapse of the Soviet economy.  This, of course, would be the moment of truth for the single currency.  One possibility---which cannot be ruled out—is that the ECB will cave in, allowing the euro to depreciate and inflation in the Eurozone to rise.  It seems unlikely, however, since the Bank is explicitly prohibited from acceding to a request for monetary financing under the institutional framework established by the Maastricht Treaty.  To be precise, there is a strict ‘no bail-out rule’ enshrined in Article 104 of the Maastricht Treaty and in Article 21 of the Statute of the European System of Central Banks.  This is the crux of what has been called the ‘unprecedented divorce between the main monetary and fiscal authorities’ brought about by EMU.

“It is therefore not difficult to foresee a series of collisions between national governments, struggling to bring their finances under control, and the European Central Bank, which is bound to maintain price stability as its primary objective (under Article 2 of the Statute of the European System of Central Banks).  The ECB is likely to ignore the ‘unpleasant monetary arithmetic’ implied by the budgetary imbalances of the member states, and to retort with some ‘unpleasant fiscal arithmetic’ of its own by raising interest rates.

“If all countries were in approximately the same predicament, a political resolution of this conflict might be conceivable.  But because there is such variation in the scale of the generational imbalances within the Eurozone, and indeed in their rates of growth and inflation, some countries will get into difficulties sooner than others.  It is not hard to foresee the kind of inter-country conflicts this could lead to.  Most attempts to assess the likely durability of EMU have sought to estimate effects of an ‘asymmetric’ shock to the system.  Generational accounting suggests that the system already has asymmetry and many not need a very large shock.”

“…Still, the fact remains that history offers few examples of democratically agreed budgetary adjustments on the scale necessary in certain European countries today. What it does offer are several examples of monetary unions between sovereign states disintegrating when the exigencies of national fiscal policy became incompatible with the constraint imposed by a single international currency.”

Hmmm!  We get the distinct impression we are inching, or possibly lurching, closer to some type of showdown on ECB monetary policy as pain spreads among the member states. 

The euro is still the major dollar alternative in the mind of Mr. Market.   And that view won’t necessarily turn on a dime.  But as Mr. Ferguson says, history offers few examples of monetary unions succeeding. 

Stay tuned, and keep an eye on the number of Google search results returned for ‘Trichet’, it could mirror the increased pressure for the central bank president to cut back interest rates and a growing crystallization in the mind of the Mr. Market that EMU is in reality a deeply flawed experiment.

John Ross Crooks III
Black Swan Capital


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