"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Thursday, November 4, 2010

Christine Lagarde On The Federal Reserve's QE2: "The Euro Bears The Brunt of the Move"

As I speculated yesterday, Europe would be hit hard by the Fed's recently announced QE2.  Just in from the Wall Street Journal, emphasis mine:
PARIS (Dow Jones)--French Finance Minister Christine Lagarde on Thursday said the U.S. Federal Reserve's new round of quantitative easing will put upward pressure on the euro and highlights the need for global coordination of monetary policies.

"The euro bears the brunt of the move," Ms. Lagarde said in an interview, a day after the U.S. Fed embarked on a new plan to buy $600 billion of U.S. Treasurys to spur the country's slow economic growth. 

"I am not making a judgment on the U.S. quantitative easing," she added. "But it shows the imperative need to rethink the international monetary system and cooperation mechanisms." 

Ms. Lagarde's comments come as France gears up to use its upcoming role as president of the Group of 20 world economies to explore ways to curb foreign exchange volatility, which is seen as a growing threat to global economic growth. France takes the helm of the G-20 at the end of next week for one year. 

Recent unilateral interventions by nations such as Japan, South Korea and Brazil to hold down the value of their currencies have fueled talk of a currency war. In the U.S. the Fed hopes that buying government bonds will help keep long-term interest rates low, boosting both consumer spending and investment by companies.
Caught between the new round of U.S. monetary easing and China's inflexible currency regime, France and the 16 other countries that share the euro currency are in a delicate position, Ms. Lagarde said.

"The euro is clearly the variable of adjustment. On the one hand, the dollar is going down with a monetary policy designed to that effect; on the other hand, the Chinese yuan is not floating freely, which means another currency has to rise," she said. 

Ms. Lagarde added that G-20 members must look beyond their national priorities to realize that cooperation on currencies would eventually be beneficial for all. 

"There are no mandatory enforcement mechanisms," she said. "We must find ways to cooperate." 
Full article HERE.
Obviously, it looks like China and the US have found a sucker, the Euro, to devalue against.  Not all major currencies can successfully devalue against each other at the same time.  It's impossible because you need a strong currency to compare your currency to; it's a relative thing.  That is, you need to find a large economy to export your inflation and products into.  Who remains?  Enter the EU.

And what of Lagarde's comment: "I am not making a judgment on the US quantitative easing"?  Does Europe have a spine?!!!!  China, Brazil, South Korea, etc... all openly complain about dollar debasement, and the EU leadership does nothing?!!!   Look, what Ben Bernanke is doing is creating the world's largest carry trade.  One that will make Japan's carry trade look meager by comparison.  It is a dangerous policy of exported inflation and bubble creation around the world that will end in economic tragedy.

Europe needs a voice.  Many of its member states are committing economic suicide by implementing austerity measures, while their currency, the Euro strengthens.  How can the member states successfully export their way out of this mess?  How can you pay back burdensome sovereign debt when your economy is experiencing debt deflation - the vaporization of money?

I think that the Deauville Meeting between Germany, France, and Russia may have covered this topic.  See my post: The Franco-German-Russian summit in Deauville.  If France and Germany don't have something up their sleeve to combat this, than they will be sorely disappointed if they think they can create "cooperation" in the upcoming G20 French Presidency.  Europe's members may work like that, but the world, at large, does not.

The Euro could also be doomed because it does not have a central Treasury.  Right now, any debt monetization done by the ECB is nation specific, meaning they don't buy EU debt, they buy Greek debt, or Irish debt, etc... so there isn't exactly one interest rate, but many.   Here's an interesting view from the Business Insider:
So why isn't the euro tanking? Only the naive would suggest that it's because the ECB seriously wants to keep its currency strong.

No, the strong euro is a further sign of deep dysfunction.

Here's the problem. In the US it's simple for Bernanke to weaken the dollar. He can buy US treasuries to reduce interest rates, thus reducing the temptation to hold dollars. It's pretty standard stuff.

But it doesn't work that way in Europe, in fact it does the opposite. The biggest downward force on the euro is the risk of a breakup, and so whenever Trichet intervenes in a market -- say, by buying Irish or Greek debt -- he's actually counteracting that gravitational force. In Europe, loose money is actually a euro positive because it reduces solvency pressure.

This is exactly what we noted in July, when we said that printing more euros would be the key to making the currency strengthen. SInce then we've seen a series of interventions, and the euro has gone up. Voila.
Bottom line: if the ECB wants to let the euro weaken, it needs to get stingier with its money, but that's too much of a risk. Thus while the rest of the world's central banks can fight the currency war, structurally the euro is shut out.

So basically  Europe may have its hands tied for now.  Only another sovereign debt crisis can "allow" the Euro to depreciate.  But such a crisis could also destroy the Euro as well.  I'm afraid the EU policymakers are playing with fire, and they're worried they may torch the whole place.

But as of an hour ago:

Trichet signals recent restart of government bond buys

FRANKFURT (Reuters) - European Central Bank President Jean-Claude Trichet gave a clear hint on Thursday that the bank had resumed its controversial purchases of government bonds last week amid renewed debt market tensions.

The premiums investors demand to hold Greek, Irish and Portuguese government debt rather than ultra-safe German bunds are at record highs, after a German-led deal by EU leaders last week raised default worries among investors.

ECB figures published on Monday showed the bank had not completed any bond purchases for the third week running last week, but Trichet said the data did not tell the whole story.

"The information comes after the transactions have been settled," he said during the ECB's monthly news conference.

"You have always information that are not real-time. They are addressing what has happened a number of working days before... you will see that the program exists."

ECB and Bundesbank heavyweight Axel Weber renewed his criticism of the purchases last month, saying they had not worked and should be phased out permanently.

The ECB publishes the value of bond buy deals it has completed every Monday but adds the caveat that the total may be higher that the published figure as the deals take a few days to settle.

Right now, the Euro is trading at $1.42.   We'll see.  Things are getting very interesting right now.  The G20 meeting next week could be full of high drama as the currency wars escalate.

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