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Posts Tagged ‘Currencies’

Euro cannot get weak enough to solve Greece’s problems due to German export machine

June 18, 2011 7 comments

If you haven’t seen Warren Moslers comments on the Euro over the last few days, they are a must read.

Greece on the Slippery Slope

Thoughts on the Euro

Germany has built a significant part their economy around exports – this was an industrial policy decision.  When the Euro weakens, Germany grows very rapidly. France also has a significant export sector, even if it is smaller than Germany’s.

We’ve seen this in the recent past when they posted the 9% quarter in Q3 2010. The lowest level of EURUSD was in Q2, so Germany got orders at low EURUSD levels in Q2, and filled them in Q3.

The euro seems to have a “natural” lower limit due to the German export machine.  Once the EURUSD trades below 1.30 or so, German growth becomes attractively large.

I find it difficult to imagine the EURUSD much below 1.20 for extended periods. Simply because if Germany is growing at 10% plus per year, their equity and debt markets become extremely attractive.  This draws capital flows into the euro, pushing up the exchange rate, ect…

Usually, a weaker currency “cures” debt problems through a combination of inflation and export driven economic growth.

But Greece does not have a large export sector – at least not to the same degree that Germany does.  A EUR at 1.2000 does not help Greece to anywhere near the same extent it does Germany.  The euro would need to be much lower to spur export driven growth in Greece or Portugal.

And we’ve seen serious problems with the inflation argument.  There simply does not seem to be that much inflation in the world.  5% inflation in China is not enough to make Greece’s problems disappear.  Greece would need an extended period of 5% inflation in Greece to solve their problems.  The ECB would never allow this level of inflation.

So the usual cure – weakening currency drives inflation AND export driven economic growth – does not apply to Greece.

The euro wont’ get weak enough to spur their economy because Germany is way better at exporting.    Inflation isn’t high enough to make the debt problem smaller on any near term time scale.

So it appears the only way for the problems in Greece to go away is a bailout.

This is what happens when you have a monetary but not fiscal union.  It seems to me like the bailout payments would more accurately be classified as fiscal transfers – as though the economics and accounting dictate there MUST be these fiscal transfers even though there is no fiscal union.

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People finally starting to notice that German Taxpayers on the hook no matter what

June 7, 2011 4 comments

A few weeks ago I pointed out that German taxpayers are going to pay for a bailout in a post.  Either they pay for Greece and Ireland upfront, or they let Greece leave the Euro and pay for a bailout of their banking system.  There is not a scenario where the German taxpayer does not pay.

Today, John Mauldin has to go to a guy from the UMKC (University of Missouri-Kansas City – this economics school is the leading place for MMT in the country) to get someone to start to say this. Even then, the lede is buried somewhere in a few thousand words.

The German taxpayers will have to pay, period.   They think they can get away from this truth, but it will – it must – happen.

From Michael Hudson via John Mauldin via Pragmatic Capitalism:

“Hudson first lays the European crisis at the feet of banks and the institutions (ECB, IMF, and the EU) that are taking the Greek (and other) bank debt and putting it into public hands. He has a very real point. Then he points out that Greece is far better off just walking away, a la Iceland (at least read the last part of this post, on Iceland). And in polls he cites, 85% of the Greek people are against taking on the debt and paying the banks.

As I wrote last week, there is a revolution going on all over Europe, slowly building up as people realize that the “solution” being offered benefits banks and not German taxpayers or Greek creditors. Ireland will be watching. There is no easy way out. If there is a referendum on this new “troika” proposal, it is likely to lose. This is not over”

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Solvency and Value, Insolvency and Debasement

March 29, 2011 32 comments

One of the stranger things about the world is that there are some ideas that are true even if we don’t believe them.  For example, no amount of work will make Pi a natural number.  If we believe Pi is a natural number, Pi is still not a natural number.  Fervent belief doesn’t change the nature of Pi.

The eternal solvency of fiat currency issuing governments is one of these things that cannot be impacted by human effort.  No matter who does what, a government issuing a currency can always pay its bills denominated in that currency.  A government issuing a fiat currency cannot be insolvent.

Jamie Galbraith lays the smackdown on insolvency:

If this is what you have in mind, then please explain: what is the “reasonable market value of assets held” by the government of the United States? Go ahead, if you want, and add up all the land, buildings, aircraft carriers and submarines. And then, don’t forget to add the capacity to produce, without limit, pieces of paper of a legal – and therefore market – value of “one dollar” each.

Can this value, which is unlimited, ever be less than the finite value of public debts? No, it cannot.

Conclusion: A government that issues its own currency and owes its debt in that currency cannot be insolvent.

Governments in control of their money cannot be insolvent.  Insolvency is the inability to pay off one’s debts as they fall due.  That’s how Wikipedia defines insolvency.

But the impossibility of insolvency does not mean the fiat currency will have value. A government might be fully solvent even with a worthless currency.  On the other hand, Solvency and currency value do not imply each other.

This distinction between insolvency and debasement is at the heart of MMT.  MMT makes a huge distinction between the process of debasement and the act of insolvency – and this distinction has massive practical implications on how governments should act.

First, it turns out solvency and currency value are confused, even by very smart people. Paul Krugman doesn’t understand this distinction.  It seems that Interfluidity is close to getting it, but he still doesn’t quite get it, because he puts a solvency constraint on governments issuing fiat currencies.  Read point SRW’s points #5-6 carefully, and then #8, and tell me he understands MMT.  Note SRW is a genius.  If SRW isn’t getting it, it isn’t his fault, its ours!

Scott Fullwiler laid out PK over at Naked Capitalism, while Pavlina Tcherneva implored him to understand over at new economic perspectives. Warren is also engaging him.

Central Banks have 2 official jobs – control the price level and get people working.  Inflation and employment are typically the only mandates of modern central banks.  But Central Banks don’t live in a vacuum – they exist in the real world alongside financial markets and the Treasury. Financial markets have concerns besides inflation and employment – heh.

What governs our interpretation of bond yields is the idea of Solvency.  Bonds trade on the perceived solvency of the issuing body.

Here is typical Bond Vigilante thinking: “Modern governments issue bonds that roughly match the amount of deficit spending of that government. Because they issue bonds, this must mean they need to borrow the money.  Anyone that needs to borrow has a risk of becoming insolvent. Therefore, governments should not issue too much debt lest they become insolvent.”

Bond Vigilantes are the ones in the market enforcing the solvency constraint on governments through bond markets. But the solvency constraint doesn’t apply to governments, so they cannot be enforcing solvency even if they believe they are.

Paul K channels every economist’s inner Bond Vigilante right here:

“I disagree. A 6 percent deficit would, under normal conditions, be very expansionary; but it could be offset with tight monetary policy, so that it need not be inflationary. But if the U.S. government has lost access to the bond market, the Fed can’t pursue a tight-money policy — on the contrary, it has to increase the monetary base fast enough to finance the revenue hole. And so a deficit that would be manageable with capital-market access becomes disastrous without.”

This is just a way of saying that a debt that is affordable at 4% interest may not be affordable at 20% interest, because of the solvency constraint. So using the tool of the printing press is a defacto admission of insolvency, therefore bypassing the bond market must trigger currency debasement. But these two ideas – the interest on the government debt and the debasement of a currency – cannot be linked through solvency, because governments issuing debt in their own currency cannot become insolvent.  Therefore, losing access to the bond markets isn’t the cause of currency debasement, because the link of insolvency is impossible.

It does’t matter what the interest rate is on government debt, the government cannot become insolvent. It could be 1000000%.   There is no point where the yields on bonds cause a run that results in the government not being able to issue more money.

Now, by this point, you must be thinking – why in the hell is he concerned with this difference?  Any interest rate of 100000% would be debasing the currency like Zimbabwe on steriods!  Why is the Traders Crucible going nuts over how many Angels are dancing about the difference between insolvency and debasement?

Well, we can directly observe the debasement of a currency  in an economy through the inflation rate. We can directly observe the process of debasement and loss of value of the currency through inflation.  We cannot directly observe the risk of insolvency – it must be inferred from bond price action.

Solvency cannot be and is never an issue, so the yield of a government bond in its own currency is divorced from solvency. There isn’t a link because the government cannot be insolvent.   This idea about government bond yields and government solvency is true even when most people don’t believe it is true. For example, it is true right now, today.  There is no link between the debasement of a currency and the bond market, because the link mechanism of insolvency is impossible.

Still, every government on the planet runs their budget with some fear of becoming insolvent. But we cannot directly observe the risk of insolvency.  So the resulting process is one of guesswork, misstatements, boneheaded plans, wild specualtion, and dumbassery, because there is no way to observe the risk of insolvency directly even though it is one of the ideas that govern our spending.

In other words, by removing the fear of insolvency, we can more directly observe the risk of debasement.

Too much spending can debase a currency through inflation.  Taking away a variable from the concerns of the government – that concern of solvency – makes the economic management process much easier. We cannot directly observe the willingness of the bond market to fund debt over the next 20 years.

These fears of insolvency are among the most serious concerns of the Fed, the Secretary of the Treasury, the President, and most intelligent observers of the Treasury bonds markets. Paul Krugman has this exact fear.

Keep in mind that Krugman is the most prominent person who has vocally questioned the existence of the Bond Vigilante.  He has many columns about how these people don’t seem to exist anywhere but in the imagination of the bond market. He has done great work for years on the bond market. Yet, here he is using the threat of the BV as a reason MMT doesn’t make sense.

But we don’t need to rely on the bond market to “give us signals” about the potential loss of access to their club to determine if we need to lower spending, or raise spending. We can just witness inflation and unemployment and make decisions on these two variables, instead of the three variables of unemployment, inflation, and insolvency.

This is a much simpler task, and is perhaps the core strength of the MMT paradigm.

Now, I am going to ask an important question: Is it the responsibility of the government to provide a low risk, long term store of wealth?  Something other than solvency must be governing the value of the currency and government bond yields today.  If something is impossible, it is impossible no matter what people do or believe. And the U.S. government cannot be insolvent.  So government bond yields right now are being governed by something other than the risk of insolvency.  I’ll say real yields are the price of an option on inflation, but that’s just wild speculation.

All we have to know is that governments cannot become insolvent if they issue debt in a currency they control.  They can issue currency, and that currency can change in value dramatically.  But we can directly observe the currency change in value through inflation or deflation.  Monitoring inflation is a far simpler task to manage than the 11 dimensional chess of inferring bond market sentiment.

We’re getting very close to the tipping point for MMT.  See Rodger?  A few decades of hard work could be followed by a payoff!

A Euro head and Shoulders means a booming Germany?

January 10, 2011 2 comments

When I look at the chart, I think maybe it is:
But when the Euro was down in the 1.20 area, Germany and France were going gangbusters. Germany and France make up a lions share of the Eurozone in terms of GDP – strap on Italy and Spain and you have a solid majority of the GDP concentrated in these 4 countries.

At some point not far from here, the short EURUSD trade becomes self-defeating.  As the Euro gets lower, Germany grabs exports.  To lesser extent, France, Spain, and Italy do as well.  This is why China is always making statements about supporting the Euro – it has nothing to do with liking Greek debt, and everything to do with liking exports to the U.S.

But let’s just look at this head and shoulders for a second.  The head to neckline distance is: .1409  A dive from the 1.2872 level means the target for the Euro head and shoulders is 1.1463.  That is well below the June lows of 1.1891, and a remarkable  10.9% below the neckline.  This is a rather large formation, and would likely take a few months to deliver this target.

So the average price of the Euro over the quarter of that it takes to reach the target, and possibly recover a bit from the target price end up something close to 1.2100 (1.2800 – .1400/2 = 1.2100).  When Germany threw down its huge 9% GDP quarter, the Euro averaged 1.2637.  Hitting the head and shoulders target would result in an average Euro price over Q1 4% lower than the 9% quarter.

The DAX did not go anywhere during Q3. My real time view of this was that nobody suspected the economy would be this strong – and this is supported by the post release, gap move upwards.

However, nobody will be surprised today. It has become common knowledge that exports drove the Q3 GDP and that Germany business confidence is booming.

People tend to like stocks and bond markets where you’re getting 9% plus GDP growth – ask China or Brazil.

As a result, I do not think the Euro will reach the Head and shoulders target of 1.1463.   As the Euro gets lower, the sovereign finances of France and Germany get much, much better.   Spain and Italy have done a bit better than expected in their deficits as well.

German companies look extremely undervalued if they are putting in 15% YoY top line growth.

This is not to say the Euro will not make another run lower, but reaching the 1.1460 level is unlikely, simply because the reasons for the trade (sovereign debt defaults) are related to how much Euro countries can export. As the Euro gets weaker, their exports get exponentially more attractive, and people will start to buy Euro products and lock in rates with forwards.  This action puts a natural floor under the Euro.

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