Friday, November 11, 2011

Euro crisis is over.



The Euro crisis is over and from what I can see that view is being embraced more broadly.

Yields on Italian gov’t bonds are down sharply again today. The markets and more importantly—the ECB—are coming to realize that the ECB is the rate setter in the Eurozone, just as the Fed is the rate setter in US dollar bond markets and the BOJ is the rate setter in yen. And the mechanism by which the central bank, in this case the ECB, sets rates is by buying or selling the securities of the government in the secondary market. NOT DOING SO would be an abrogation of their role. Just as the Fed can set rates anywhere along the term structure or, even on mortgages, the ECB can set rates on Italian, Greek, Irish, Spanish, German, French or any other debt in the Eurozone. That is its role even if it is reluctant to do it. It is finally coming to terms with that and doing it as needed.

So this removes the solvency issue entirely at this point. As the markets come to realize this, and I believe it will be rather quickly now, there can be a huge relief rally.

Where we go from here depends on policy measures related to ongoing austerity. Austerity deflates economies and that means weaker growth, higher unemployment, not just in the Eurozone, but here as well. That will take time to play out because it is a political process, however, I see nothing in terms of policy that would suggest austerity will not be the norm going forward.

One final note, this is NOT MONEY PRINTING and NOT INFLATIONARY as some analysts are saying. That’s because the buying of bonds by the ECB is merely the removal of one asset from the public—the bond—and replacing it with a cash balance at the ECB. The only thing that has changed is the interest rate and the duration. The public is stripped of a bond interest coupon that pays a pretty high rate and gets a cash balance at the ECB that pays 1.25%. It is therefore stripped of income. This is not inflationary. The duration of the public’s assets has shifted from longer term to zero term (cash). That’s all that happened.

To the extent that markets perceive this as money printing or inflationary they will buy gold or commodities or sell bonds or whatever, but those moves are not likely to hold up.


16 comments:

Theron said...

Excellent analysis!

Theron said...

Mike,

Should I be buying Greek bonds?

Anonymous said...

This won't go forever, also I think this is pretty much discounted in the stock market ("ECB will print money"), so no huge rally there (anyway it has already decoupled).

No growth anyway so it doesn't matter much, just can kicking.

Tom Hickey said...

I agree that it is a step forward on the financial scene, Mike, but as you say, the specter of austerity still looms, and the real problem in the EZ is now political as populations revolt against the cram down on them (99%) to remedy the mistakes of the financiers (1%). this trend is only going to increase unless the EZ masters realize that the real problem that the EZ faces is lagging aggregate demand, requiring fiscal injection.

Monetary is rather simple to do politically, since the ECB is "politically independent," but fiscal is not. There are all kinds of rules involving fiscal moves, and many of these require political approval. That's still gong to be the sticking point.

The ECB buying bonds could even exacerbate the problem somewhat by removing the interest that would otherwise have been paid, some of which would possibly have been spent.

So while the financial crisis may be ameliorating, the real crisis is still very much in play as economies contract and the people revolt against what they perceive (correctly) as a deal that rescues lenders on their backs. Now that the Occupy movement has gone viral globally, this is going to be a big issue going forward. Too many people realize that is this is not a aberration, but the setting up of a new global order under technocrats who are "interested men" in Tom Paine's sense.

Mike Norman said...

Tom:

Yes, I think that's probably the "second phase" of the crisis, the economy. This will take time to play out because it will evolve on a political timetable as opposed to a market timetable (which is much more accelerated).

Theron:

I think so, but I admit it's still hard to pull the trigger for the simple reason that, while the ECBs "backstop" of the eurobond market is the rational thing to do, people and institutions are still prone to irrational acts. Who knows, maybe Merkel convinces the ECB that its actions are inflationary and they just stop doing it. Right now I'm saying that's a low probability, but it's a probability nonetheless.

SchittReport said...

mike, much as i'd like to share your optimism about the reversal of stupidity in Euro government policy or ECB policy - i don't think you've got this one right.

http://www.ft.com/cms/s/0/78d291a6-0c3d-11e1-8ac6-00144feabdc0.html#ixzz1dPm5ofGe

"Italian bond yields fell markedly for a second day running, after investors took heart from signs that Mario Monti, a technocrat, is set to take over as the heavily indebted country’s new premier."

so basically the market had a dead cat bounce on the premise that there will be no more wastage of taxpayer's money on bunga bunga parties and nude teenage catwalk shows at berlusconi's mansion - NOT because of any sea change in ECB monetary policy.

SchittReport said...

also...

http://www.cnbc.com/id/45251717

googleheim said...

MIKE

YOU MAKE A GREAT POINT.

THE KNOWLEDGE OF THE TRUE WORKINGS OF CURRENCY THEORY IS FINALLY GETTING A HOLD IN EUROPE ...

THE PROBLEM IS THAT IT IS PIECE MEAL IN STEPS.

IF THEY WOULD EMBRACE OR AT LEAST TAKE AS A MATTER OF PERSPECTIVE THE MMT MODEL, THEN THEY WOULD HAVE BETTER ANGLING AND ACTION.

THERE ARE SEVERAL HURRICANE MODELS FOR PLOTTING PROSPECTIVE PATHS, AND SAME IN ECONOMICS. IT IS THE EUROBOYZ FAULT FOR NOT SEEING THE MMT MODEL.

SO FINALLY THEY REALIZE THEY CAN SET THEIR RATES

BUT, BUT, BUT, BUT

WITH MMT GOGGLES WE CAN SEE HOW INSIPIDLY HARSH THE NORTH COUNTRIES HAVE BEEN TO THE SOUTH COUNTRIES.

1. IF THEY ARE IN A TRUE UNION, MERKEL WOULD NEVER SAY THAT MULTICULTURALISM IS A FAILURE ! INSTEAD GERMAN MILKS TURKISH LABOR TO BUILD BMW'S AND MERCEDES.

2. IF THEY WERE IN A TRUE UNION AND KNEW THEIR MMT DEGREES OF FREEDOM, THEY WOULD SET RATES AS AN ENTIRE NATION AND NOT AMONG THE STATES.

3. WHAT THEY ARE DOING NOW IS SETTING RATES FOR EACH COUNTRY INSTEAD OF THE UNION !!??

I UNDERSTAND THAT TEXAS AND CALIFORNIA HAVE THEIR OWN BONDS, BUT SOMETHING IS MISSING IN THE COHESIVENESS IN THE EURO SYSTEM THAT IS FOUND IN THE USA SYSTEM.

THEY HAVE TRULY NOT FORMED A UNION LIKE THE USA

CAN ANYONE EXPLAIN THE DIFFERENCE BETWEEN FED-RESERVE RATES & USA STATES BONDS VERSUS THE ECB & EU STATE BONDS ?

WHAT IS DIFFERENCE ?

googleheim said...

it seems to me that the EU is not a union when it comes to a particular state having problems.

are we ready to kick california out of the union because they got into debt ?

it really helps us that the federal reserve helps california by "printing" because it generates activity across the nation

austerity fights this and retracts money liquidity out of the engine when it needs it the most

once upon a time a homeless guy on a bicycle told me not to add water to an overheated engine if the motor is not turning. i did not take his advice and a head gasket blew

the point is that if austerity seeks to stop the engine ( remember Gingrich gov closures ) and retract money out of the economy ( remember Clinton balancing the budget ) then you try to add coolant - the engine will crack and take more maintenance than neeeded in the first place

gingrich == clinton in retrospect

austerity is heat that lowers liquidity

austerity is an agenda of control by politics and tricksters

the gasket that broke here is Greece - and it is the fault of Germany and France and ECB

Greece should go to the Drachma and then monetize all of their debt as well as pulling an Argentina and putting all investors in a pool and paying pennies on the dollar back

then the EURO will SPIKE in value and it will be too expensive to buy those BMW's and Mercedes made by Turkish "multicultural" workers

Matt Franko said...

Goog Michael Hudson had an article recently where the polls over there show most people "like" the idea of a Euro currency....

so it will probably not be good going forward but as Mike points out they seem to have stumbled upon some sort of "arrangements" that should remove the "solvency" issue at least, but still at the expense of "austerity" of some forms in the deficit countries for now....

"Volatility" should perhaps fall from recent higher levels if the situation over there starts to settle down because of this.

Resp,

Anonymous said...

Right. It solves the national solvency issue, but not the aggregate demand issue. The banksters will keep it up until they own Europe and blood flows in the streets in protest (which will get them nowhere in the last analysis). Protest can always be handled with big guns and economic pressure.

Anonymous said...

It even does not solve the national solvency issue.

Sure they can maintain states at the brink of insolvency (and push "austerity" and "structural reforms") or make insolvent countries solvent again (if "austerity" pushes are deemed enough) through bond buying.

Yet, they are managing the single currency not as fiat but as a gold standard currency.

Therefore, deflation, recession, growing unemployment follow - and state revenues decline. States will continue in deficit.

Unless the EZ becomes a huge net exporter - to which countries?

Darker times menace the EZ but not only the EZ...

Matt Franko said...

Anon,

The "crisis" of the solvency issue yes is over and yes the slower self-mutilation continues... Resp,

TomatoBasil said...

Is Draghi responsible for your Change in view? It appears he lowered short term rates and is willing to defend rates over the term structure for members...

Joe C said...

The Guardian headline on the Italian austerity measures includes the description of "savage cuts" but lacks details on those cuts. The Italians have taken to the streets, but only to celebrate Berlusconi resigning.

http://www.guardian.co.uk/world/2011/nov/12/silvio-berlusconi-resign-italy-eurozone

In three months, when Italy's GDP shrinks, they will ask "Did we not cut enough? No, we didn't. Another round of austerity."

Anonymous said...

@Matt Franko

From anonymous 1 L-)

Exactly right. It solves the solvency issue.