Wednesday March 10, 2010 - 15:29:28 GMT
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Black Swan Capital - www.blackswantrading.com
Why will the euro eventually go to par or beyond? Basic macroeconomics!
German exports posted their biggest drop in a year in January, throwing the economy's main growth engine into reverse at the start of 2010, but a surge in orders suggests the decline will be temporary. (Reuters)
Australian home loans fell the most in nearly eight years in January. (Reuters)
Quotable â Sums up European Government Propaganda on Greece (PIGS) Crisis
âI had therefore to remove knowledge, in order to make room for belief.â
FX Trading â Why will the euro eventually go to par or beyond? Basic macroeconomics!
Remember, macroeconomics is like working with Playdough. When you push on one spot, there is a similar or equal reaction in anotherâŚ
A surplus here, is a deficit there ... that type of thing. It explains why austerity for all the bad children in Europe wonât work.
Just get on a strict diet of austerity, you nasty little PIGS, and everything will be just fine in the end. Yeah. Sure Mitch!
âUnfortunately, the domestic German debate assumes, wrongly, that the answer is for every member [of the EU] to become like Germany. But Germany can be Germanyâan economy with fiscal discipline, feeble domestic demand and a huge export surplusâ only because others are not,â Martin Wolfe writes in todayâs Financial Times.
Fiscal indiscipline is a problem, no doubt. But it does not go to the core of the problem. Martin Wolf says it this way:
âGermany insists that every country should eliminate its excess fiscal deficit as quickly as possible. But that can only happen if current account balances improve or private balances deteriorate. If it is to be the latter, there needs to be a resurgence in private, presumably debt-financed, spending. If it is to be the former, there are two choices: first, current account balances must deteriorate elsewhere in the Eurozone, entailing a move to smaller private surpluses in countries like Germany. Or, second, the overall balance of Eurozone must shift towards surplusâa âbeggar they neighbourâ policy,â Mr. Wolf summarizes.
Think of the Eurozone as a total economy by itself for a moment. Then I think you can better understand the little microcosm of imbalances.
Germany (France to a lesser degree on consumption side) is the âover producer and under consumer,â and the rest of the countries are the âunder producers and over consumers.â This has always been good for Germany in the past, as these over consumers, who increased their private and public debt to purchase German goods, couldnât buy them fast enough; which is why Germany retained the mantle of worldâs largest exporter, till it was dethroned in 2009 by the Chinese juggernaut.
This captive base of consumers in Europe is one of the primary reasons why the euro came into existence in the first place. It seems unlikely Germany would not have given up its D-mark for the euro if it did not see a huge advantage for its industrialists. Thus, why the credit crunch has been the game changer; no longer are the over consumers in a position to buy as they did before the credit crunch. (Does this sound familiarâinsert China in the place of Germany here and the US in the place of the over consuming countries of the Eurozone.)
Viewed this way, you can see why Germany takes a big hit to its exports if austerity is the only measure taken by the over consumers. If they become austere, they donât have the money to buy German goods. If the over consumers must rebalance their fiscal deficits, through trade alone, they will be forced into the âbeggar thy neighborâ policy that will only increase political tensions in a zone that is already rife with tensionsâas the old warring tribes of Europe are starting to beat on the drums. [This is evidenced by the recent very public lashing out at Germanyâs Nazi past by Greeceâs deputy prime minister. And weâve been told privately itâs even worse.]
Is Germany prepared to start consuming more and exporting less to rebalance the zone? Unlikely as a policy choice. Imagine saying to the your German votersââWell guys, we need to be relaxing more, taking on more debt, and producing less, so that we can be less competitive compared to our Eurozone comrades.â Ainât going to happen, we donât think.
A beggar thy neighbor trade policy from the fiscal basket case countries to reduce their current account problems seems unlikelyâthe over consumption that got them into trouble in the first place is precisely because they donât have even close to the labor productivity as Germany; and its gotten worse as the Eurozone has âprogressed.â
Back to Mr. Wolf [our emphasis]:
âLet me put the point starkly: Germanyâs structural private sector and current account surpluses make it virtually impossible for its neighbors to eliminate their fiscal deficits, unless the latter are willing to live with lengthy slumps. The problem could be resolved by a eurozone move into external surpluses. I wonder how the eurozone would explain such a policy to its global partners. It might also be resolved by an expansionary monetary policy from the European Central Bank that successfully spurred countries and also raised German inflation well above the eurozone average.â
We are betting on a European Central Bank cut. Mr. Wolfâs summary today is precisely why we have written in Currency Currents recently that we expect such an event and why the real or future perceived growing positive yield differential between the euro and the dollar will be yet another reason to favor dollars; the other reason of course is relatively stronger US economic growth.
And going back even further to our writing, we wrote this back in June 2009 in our Special Report on the potential Demise of the Euro:
By virtue of one central bank for 16 different countries suggests to us an inherent flaw. Granted, globalization has led to more synchronized business cycles among all countries, but there will always be discrepancies. And with 16 potential business backdrops, and the ECB effectively focusing on Germanyâs needs first and foremost, there are bound to be tensions. Up until very recently these tensions have been muffled. No more. We are now finally starting to see public bickering among the various ECB council members. No surprising given the asymmetrical shock is upon us.
The bickering is about how loose the ECB should be going forward. The Germanâs want more austerity and conservatism, always afraid of stoking the fires of inflation, while others want more ease and liquidity as financial pressure build across the zone. In addition to more ECB ease, many states want increased aid from Germany.
Before we go further here, it is important for us to emphasize that German has been more than happy to provide more than its share of subsidization of weaker states in the European Union. It is a quid pro quo. Germany effective controls monetary policy and the creation of the EMU gives Germany industrialists a captive common market to dominate. But now, as we told you in the introduction, the game is changing and Germany is no longer receiving its benefit from the Union as demand for German goods plummets across the region.
Juergen Stark, the Bundesbank ECB Council member issued a public warning to the German government that bailouts of other weak EU Members would be a violation of European Union Law, specifically prohibition against monetary financing of government expenditure.
These comments come on the heels of Athanasios Orphanides of Cyprus (with deep connections to the U.S. Federal Reserve), George Provopoulos of the Greek central bank, and Ewald Nowotny of Austria recent Cyprus calls for near zero interest rates and quantitative easing by the ECB. Bundesbank President and ECB Council member Axel Weber came down hard against both central bank purchases of assets from banks as well as against policy interest rates below 1%. This incident was reported this way: This is the first time in the history of the European Central Bank that its Council members are engaged in a major dispute over policy in wide open public view, as reported by Leto Research.
We have been fortunate to have a friend who knows a whole lot about Europe. And fortunate that this friendâs friend -- a proprietor of Leto Research â is a truly brilliant man on global macro dynamics (we quoted him in our original Euro Demise report). Given he is of Greek origin, he knows much more than the average bear about Greece and its historical interrelationship with the vaunted Eurozone. He summed it up this way in a research piece this week:
âPortugal, Spain and Italy are similar to Greece. In just the same way as Greece, their debts arose from financing the purchase of goods and services from Germany and France (and their satellite economies of Belgium, the Netherlands and Luxembourg). The root cause of their indebtedness is the same: the fact that the Eurozone, despite claims to the contrary, was never anything more than an arrangement to secure captive markets for German exports. About 50% of German export surpluses come from âClub Medâ countries. Unless that arrangement is overturned, Portugal, Spain and Italy will follow the path to oblivion that Greece has entered: First, a wave of austerity that cripples economic activity and shrinks the taxable base, then asset stripping ordered by a future European Monetary Fund to the benefit of German creditors.â
Our call: EURUSD goes to par against the dollar or possibly well beyond. Keep in mind, EURUSD once traded at around $ 0.8300. Stay tuned.
Black Swan Capital
Currencies are another asset class âŚ
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All the best,
Director of Sales and Marketing
Black Swan Capital [email protected]
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