Posts Tagged ‘Draghi’

Currency War Is The Continuation Of Stimulative Policy – And Politics – By Other Means

Wednesday, February 20th, 2013

One does not generally think of G20 communiques as hilarious, but Carl von Clausewitz might have been amused by the one put out over the weekend (Prussian military theorists are known for their sense of humor) and perhaps honored its comic genius with the above corollary to his famous maxim*. The document essentially re-classified recent competitive currency devaluation, without even calling out the tactic by name, as one of a variety of “policies implemented for domestic purposes,” on the part of G20 members seeking to “minimize” “negative spillovers” on other countries.

Got that? So when the Fed prints money to fund QE “infinity and beyond” and the dollar slides against the euro it’s just a “spillover,” as is apparently the effect of Japanese Prime Minister Shinzo Abe’s call for a weaker yen (precipitating a 20% dive) since he’s just trying to stimulate his “domestic” economy. Indeed, as market commentators seized on the G20 statement as a ratification of Japan’s devaluation policy, the point of the group’s statement became clear; one might paraphrase it as “hey, big advanced economies, we’re cool with you devaluing – just call it quantitative easing or monetary stimulus and try not to be too obvious in stating how low you want your currency to go.”

The problem, of course, is that for any nation that trades with the world, there really is no such thing as a purely “domestic” economic policy. For example, when a nation’s central bank creates currency to buy financial assets in quantitative easing, all that money printing can drive down the value of the currency versus that of the country’s trading partners, giving the QE the added stimulative kick of improving balances of trade and payments. The US may well be enjoying this effect, while Japan, facing monstrous energy-driven trade deficits in the wake of its post-Fukushima near-total nuclear shutdown, desperately wants to increase exports. Indeed, the newly-elected LDP government has entertained purchasing foreign bonds to flood the world with cheapening yen, though Abe downplayed the need for going this far following both the yen’s plunge and the G20 summit, perhaps fearing the optics at the moment.

The fall guys in a currency war tend to be the countries that don’t devalue, a point not lost on ECB president Mario Draghi, who only a few months ago stated his intention to “fully sterilize” Outright Monetary Transactions – his own quantitative easing – and prevent a decline in the euro, presumably by using foreign currency reserves to mop up the excess euros used to buy Eurozone bonds. That was a nod to inflation hawks like Bundesbank president Jens Weidmann, who fear currency debasement may lead to higher prices, but it was also before the G20 devaluation love-fest. Right after the summit, Draghi made clear that while he was not targeting a specific exchange rate (of course not – after all, he read the communique) he was cognizant of the “deflationary” effects of too strong a euro. Translation: “Hey folks – I’ve got a printing press, too!”

Of course, in a policy free-for-all like the one the G20 just had, there has to be something in it for everyone, including emergent economic powerhouses like the BRICs. Thus the comment about the need to “minimize” “spillovers,” including measures to prevent all that newly-created, developed-world “hot money” bidding up and crashing developing nations’ domestic markets as it roars in and out of their economies. In other words, the new kids on the block get a green light for currency controls.

Beggar thy neighbor devaluations, protectionist currency controls…this kind of thing can get very out of hand, with bad consequences, economic and otherwise. As the G20 expands the scope of this game, its members had better learn to play nice. After all, past competitions of this kind have preceded events which prove the veracity of von Clausewitz’s observation.

*“War is the continuation of politik by other means.” Then as now, the shadings of the translation of politik (policy or politics, depending on the translator) are both intriguing and ominous.

Aware of Greeks Tearing Rifts, Germany May Have To Let The ECB Do More Than Twist

Thursday, June 28th, 2012

As the prospect of Brussels hosting yet another euro-summit showcase of intransigence and impotence looms before us, even the redoubtable Angela Merkel may be forced to contemplate allowing the European Central Bank to become quite a bit more like the US Federal Reserve. Otherwise, European divisions made obvious during the latest Greek elections may become irresistible tidal forces as the crisis reaches Spain and Italy, opening an economic chasm into which even Germany could fall.

In the wake of two rounds of “quantitative easing” that have left the Fed owning about 12% of US Treasury debt, the Fed has announced its intention to continue attempting to stimulate the economy by extending “Operation Twist,” selling shorter dated Treasuries and buying longer maturity T-bonds in order to bring down long-term borrowing costs (see “Uncle Ben’s Reverted Price”). But US long rates are already quite low, indicating that, at least for the moment and despite past and potentially future fiscal fireworks on Capitol Hill, the bond markets remain rather unconcerned about US credit quality. This may be in no small measure due to the Fed’s demonstrated willingness to purchase massive amounts of Treasuries.

By contrast, as euro-crisis contagion spread from Greece to the rest of the periphery, the sharp rise in the yields of Spanish, Italian and of course Greek debt speak to markets’ deteriorating faith in these credits. For a time these rate hikes were held in some check by ECB sovereign debt purchases; since 2010 the central bank has bought some 200 billion euros of Portuguese, Irish, Italian, Greek and Spanish (PIIGS) paper, creating a degree of precedent for this kind of strategy. However, unlike the Fed, the ECB’s constitution does not include a mandate to pursue full employment in addition to maintaining price stability, so the euro’s central bank was forced to act in the name of maintaining the integrity of the banking system, whose collapse could be deflationary. Two German ECB members took such exception to this rationale that they resigned in succession, reflecting Germany’s traditional post-war concern regarding inflation. For Mario Draghi, the ECB president who recently highlighted the limits to what the central bank can do absent fiscal and structural reform in Europe, much more substantial action would likely require German support, and the quid pro quo of at least a somewhat credible promise of that reform.

Like their American counterparts, the yields on German bunds are quite low. And for Germany as for the US, these low yields are not due to low debt to GDP ratios, as the German figure is now near 90% and likely to rise significantly higher with the announced issuance of Deutschland bonds through which the central government will back borrowing by German states. Rather, both the US and Germany are in some sense in command of the mechanism for creating the currency in which they borrow; for the US this power is unambiguously invested in the Fed, while Germany enjoys a kind of negative control of the ECB, since with the exception of Finland and the Netherlands, the rest of the eurozone seems to have little objection to money creation through policies such as sovereign debt purchases.

A crucial point here, and one readers of this blog will be familiar with, is the difference between real default on sovereign debt caused by inflation and nominal default, in which the bonds do not fully pay off, even in a depreciated and inflated currency (see “Europe Learns To Default The American Way, Restoring Transatlantic Balance Of Irresponsibility”). Because the latter does not result in an inability of banks and other holders of bonds to meet their obligations (like deposits) payable in the same currency as the bonds, the real default of inflation, though potentially quite pernicious, may not precipitate acute systemic financial crises, and thus institutions may be willing to hold debt at risk of inflation but not nominal default. So at least until the inflationary crows hatched by monetization come home to roost, a central bank’s buying of its currency’s sovereign debt may lower yields on that debt, as may even the possibility of such buying, based on the central banks’ ability to make such purchases.

Germany is understandably wary of letting profligate states borrow on its credit card. If it’s serious about not allowing eurozone-wide “Eurobonds” to refinance peripheral debt, and with the necessarily limited firepower of bailout funds like the European Financial Stability Facility (EFSF) and its successor, the European Stability Facility (ESM) limiting their credibility, an ECB with the theoretically unlimited power of the monetary printing press may have to be the buyer of last resort for the debt of the PIIGS, effectively creating euros to re-liquify the banking system, preventing runs and reflating the eurozone’s economy. For Germany, staying in the euro absent such an action could mean the loss of its periphery export markets while its own bank exposure to those countries drags the German economy down (see “It’s Hard To Make That German Export Wiener Without PIIGS – And That Goes For Chinese Dumplings, Too.”). Alternatively, a report from Merkel’s own government puts the cost of an exit from the common currency at 500 billion euros, with a 10% GDP drop and five million Germans unemployed.

Ah, but there’s the matter of those inflationary blackbirds I mentioned, and an old Spanish saying – if you raise crows they will peck out your eyes. With eurozone inflation running at 2.4% in May and the German rate even lower (1.7% in June), the ECB has some inflationary breathing room, ironically due to a global economy weakened by the euro crisis itself. Yet Germany’s concerns are well founded, and in exchange for a more Fed-like ECB it could and should insist on rapid reforms in Europe. These would have to go beyond austerity and the purely fiscal, embracing structural changes addressing woefully low competitiveness in much of the eurozone. Only then can there be confidence in a limit to monetization and any hope of peripheral countries paying debts current and future. Clear milestones and a commitment to a time scale much faster than the ten years contemplated in European Council President Van Rompuy’s plan would be essential. Unfortunately, the most serious opposition to such reform is likely to come from the new French government, which would have to reverse the newly elected François Hollande’s support of earlier retirement benefits and restrictions on layoffs even as French competitiveness dives.

But hey, what in the last two hundred years of Franco-German relations would cause one to doubt that France and Germany can’t work things out?

“Send Treasury Your Retired, Your Not-So-Poor, Your Befuddled Classes Yearning To Invest Risk-Free…”

Thursday, February 9th, 2012

If they continue on their current course, the architects of America’s fiscal and monetary policies might want to consider the above revision to Emma Lazarus’ great exhortation on the pedestal of the Statue of Liberty. For it is in no small measure the flight of capital from investment on other shores that’s has been driving down yields on United States Treasuries, allowing the US to borrow with remarkable abandon despite ratings downgrades and Washington’s ongoing budget follies. As forbidding as the US debt and deficit might be, last year investors continued to bid up America’s debt, lowering the interest cost to finance economic stimulus programs while keeping tax rates unchanged. This injection of capital has almost certainly helped to spur the nascent US recovery, just as some economists argue pre-war European flight capital helped lift America out of the Depression in the later 1930’s.

Washington has had various factors to thank for the easy credit terms the world continues to offer. From Iranian saber-rattling to Japanese earthquakes, many forces served to drive frightened capital into the arms of the US Treasury market. However, at the top of the list is surely the political leadership of the Eurozone. The Obama-Boehner show has nothing on the extravaganza headlined by Merkel and Sarkozy, with a supporting cast of various and changing guest stars governing the solvency-challenged PIIGS (Portugal, Ireland, Italy, Greece and Spain) and of course the folks at the IMF and ECB (every comedy needs a few straight men and women, after all). This noisome cavalcade had provided a continuous flow of confidence-shaking news, keeping sovereign default risk and systemic shock ever present in investors’ minds. Meanwhile, the US has muddled through a budget deal which, while insufficient in the long run, indicated some capacity for concord even in the current poisonous political atmosphere. Similarly, the Fed, aided by TARP financing, seemed to succeed in stabilizing the American financial system. Through late in 2011, the result was an increase in the cost of euro-denominated borrowing for key large Euro sovereigns with the exception of Germany, the yield on whose bunds declined almost in lockstep with a simultaneous drop in US Treasury bond yields.

At the time of this writing, with the “voluntary” Greek debt restructuring talks dragging on, observers may understandably have a difficult time conceiving of an end to “Euro-fear.” Nevertheless, it is precisely the possibility that, with or without Greece in it, the Eurozone will find a way to get its house in some kind of order that threatens America’s ultra-low borrowing costs. We are in fact seeing some tentative signs of, as Churchill put it, not the end or even the beginning of the end, but perhaps the end of the beginning.

New ECB president Mario Draghi’s Long Term Refinancing Operation ostensibly provides a three-year, multi-hundred-billion euro stabilization line of credit to European commercial banks, but as the ECB is “allowing” (read: encouraging) those banks to use this credit to buy better European sovereign bonds (and avoid having to dump weaker Euro nation credits in bulk) what we’re really seeing is a back-door program to lower European states’ borrowing costs. Because the ECB loans represent money created by the central bank, this is a form of bailout that does not require direct taxation of “core” European nations citizens (e.g. Germans), though to be sure, they may end up paying the price through inflation (see “Europe Learns To Default The American Way, Restoring Transatlantic Balance Of Irresponsibility”) and devaluation, though export-driven economies like Germany actually need a weaker currency more than they might like to admit (“It’s Hard To Make That German Export Wiener Without PIIGS – And That Goes For Chinese Dumplings, Too”).

Second, whether or not the Greek debt restructuring talks result in a formal default or an effective one (and the contemplated 70% write-down will surely be a default in fact if not in name) is not so important as whether the process is orderly. So long as any any write-offs and triggered credit default swaps are handled in a way that does not lead to bank runs and frozen markets, such an event could be kept contagion free. There is no guarantee such a systemically benign scenario will play out, but the aforementioned willingness of the ECB to inject liquidity on a massive scale does provide reason for optimism.

And therein lies the rub for US government borrowing costs: as the Eurozone crisis subsides, so may the safe haven “panic bid” on US Treasuries, causing the yields on those bond to rise and further increasing the burden on American taxpayers of financing the deficit. Indeed, the 10 year US Treasury yield has crept up from below 1.87% in late November of last year to over 2.02%, while conversely (and despite it’s own rating downgrade), France’s ten year debt yield declined to below 2.90% since spiking above 3.73% during the same period. Similarly, the Italian 10 year yield dropped from over 7.36% to less than 5.49%.

To be sure, there are significant benefits to the US economy in this “risk-on” shift; the reduction in Eurofear has bolstered equity markets with a knock-on wealth effect boosting consumption and, yes, tax-revenue even in the absence of a rate hike. Even so, higher T-bond rates translate into an increased cost of servicing America’s heavy debt, so even if the core Euro countries seem to be picking up the tab, their Greek holiday may not come without cost for Uncle Sam.

N.B.: One advantage of a weakened euro – cheaper French wines (in dollar terms), and in particularly that said-to-be-excellent 2009 Bordeaux vintage; for insight into this and all things vino, check wine expert (and Duke econ grad) Jessica Bell’s very excellent webcasts at