Foreign Exchange Outlook : The IMF chief economist said this is the greatest shock since the 1930’s but should not turn into another
Great Depression because the policy response this time will be the right one. The major countries will not raise interest rates and has instead cut them, trade protectionism will be resisted, and so on. But what about the public’s response? Is it possible that governments can do the right things and we get a Great Depression anyway?
Bloomberg points out that yesterday the VIX, a measure of fear in the stock market, reached an intraday record high of 59.06.
Stock markets are not economies but have many of the same participants. Stock market participation in the US is exceptionally high, with well over 60% of individuals having some association with it, if only through a pension fund or IRA. At what point does the government, any government, intervene in the stock market to boost confidence? It is seldom done-the number of instances can be counted on the fingers of one hand (Hong Kong during the Asian crisis, Japan via state-owned entities at various times).
We doubt that the US would do it-Congress would scream-but hey, you never know.This is a new form of moral hazard-that once the Treasury decides it can buy preferred shares, it selects its investment targets according to the free-market fortunes of certain stocks. This would be truly awful and raise all kinds of questions about insider trading, stock price manipulation, backdoor deals, and so on.
The US reputation for honesty and transparency has already taken near-fatal stabs to the heart by Enron, WorldCom, various option pricing scandals, executive pay, and so on.How much more can it take?
We agree that preferred shares are a better fix than buying toxic paper and praying, but it must be handled with kid gloves and in the middle of a well-lit stage.
Anyone pinning hopes on G7 tomorrow and Saturday is making a mistake.
Treasury Sec Paulson said yesterday that "When we look at the G-7, we have very different countries, economies of different sizes, financial systems with different needs. And so it would not make sense to have identical policies." What he really means is that monetary policy has little to contribute now-although the coordinated action yesterday had a good effect and gave a nice appearance, as though somebody is in charge-but fiscal policy and institutional change are now the keys to a real and lasting fix. As noted before, the eurozone doesn’t have a joint fiscal position. There is no federal budget of any consequence. Therefore, it’s up to each country to fund their bailouts as best they can, and national differences and quirks are only to be expected.
Does this mean the euro-zone is in a weaker position than the US? Not necessarily. These guys are not second-raters. They have already accepted that budget deficit constraints (3% of GDP) need to be thrown out the window. What else do we need? Each country’s plan doesn’t have to be coordinated with everyone else’s plan to be effective. The real problem lies with the big multinationals that have fingers in every country, like
ABN Amro,
ING,
Deutsche Bank and the British banks. As we saw with Iceland, we could end up with governments suing each other. Iceland doesn’t have the cash reserves but most EMU countries do, or the capability to tax it into existence. This will be fun but not fatal if it’s the UK suing (say) France, but it will be less fun if it’s Poland suing (say) Germany. We have no evidence that this will be the outcome, but it’s an interesting idea.
More interesting is how Europe is going to reduce leverage without triggering failures. This is still under the radar but it seems obvious that leverage of 50x is a fire waiting for a match.
Meanwhile, European banks are still bidding like mad for dollar funding from the
ECB at rates reaching 10% yesterday, although it was down to 5% today. With Fed funds at 1.5%, this is an extraordinary premium. Usually overnight money is cheaper (due to the absence of reserve requirements), not more expensive. We will know that trust and confidence has returned to European banking when these rates come down. What if they do not come down? At a guess, it means the European banking crisis has further to go.
European banks are almost certainly in worse shape than US banks at this point.What does this have to do with the level of the
euro exchange rate? It’s murky. The rising
euro rate is a sign of confidence in European institutions, including especially the ECB. We find this mysterious, since the ECB raised rates only in July, evidently not having read Mr. Bernanke’s book on the Great Depression, which repeats the accepted wisdom that the Fed raising rates in 1930 was precisely the wrong thing to do.
Why are the ECB and the Euro Exchange Rates not being punished for foolish policy choices?If and when the US and UK do these things, the pound and dollar exchange rates get punished.Well, it’s the Teflon euro.We see this effect repeatedly. For example, money supply growth never once hit ECB targets during the entire life of the
ECB but the
euro dollar didn’t get sold off because of it. We offer only the idea that the idea of monetary union is such a fine one for countties that had spent 1000 years fighting wars against one another that the markets are willing to overlook little things like 50x leverage. Does this make sense? No. But it’s a lesson in why Big Picture macroeconomic analysis doesn’t help much in
forecasting exchange rates.
Charts are more realiable. This time the chart is saying that the pullback in the euro is just that-a corrective pullback. We will not
Buy Euros into it as a reversal for hundreds of points more, probably not until it breaks the channel top resistance over 1.4200 or 1.4300. We can try to buy the euro correction, but beware-it can spit in your face. As for the
Japanese Yen, the
US dollar got a boost on short-covering on the Paulson announcement that the Treasury can do preferred shares-but Japanese companies are still planning as though the break below 100 is the real deal and they are in for an ordeal.
Euro to Japanese yen is going to be very interesting-what is the real driver?
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Barbara Rockefeller -
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