Another post from Tim Duy:
Waiting, Waiting, Waiting, by Tim Duy: US markets are closed, with everyone left waiting for the news from Europe and the 3Q11 US GDP report. Expectations appear to be high for both, but I am considerably more certain the latter will deliver on those expectations. Europe is certainly more interesting. Over the last few weeks, market participants looked to have grasped at every little straw that offered hope on the European story, and it remains to be seen whether or not that will continue when rumours turn to news.
I remain something of a Euroskeptic at this point. At best, I think the Europeans will be kicking the can down the road for a few months. Some specific concerns:
The goalposts are already moving. The Eurozone economy is headed into recession - the combination of fiscal austerity and financial turmoil have already set in motion the inevitable contraction of demand that will soon threaten deficit reduction goals across the continent. And it is only a matter of time before the ratings agencies recognize this as well. The European solution, of course, will be additional fiscal austerity. It didn't work in Greece, and it won't work for the Eurozone as a whole.
The lack of sufficient ECB participation. The German contingent has effectively shut down the ECB. From the Wall Street Journal:
Lawmakers also pressed Ms. Merkel to push banks considered systemically relevant to raise core capital to 9% by a deadline of June 30, 2012 and urged her to insist on an end to the European Central Bank's program of purchasing euro-zone bonds on the open market to prop up weakened euro-zone members as soon as the EFSF is launched. German lawmakers also called for a clear European commitment to the ECB's independence.
The Germans fear the inflationary consequences if the ECB essentially monetizes the debt of the periphery. But the lack of a credible lender of last resort is crippling rescues efforts, and will continue to do so.
When in doubt, turn to financial engineering. The faith in financial engineering never ceases to amaze me. Efforts to leverage up the EFSF are almost comical, and they reveal another problem in this exercise - no one (in particular, Germany) is willing to bring sufficient resources to the table. Wolfgang Munchau:
Leverage can have different economic functions, but in these cases it simply disguises a lack of money.
The whole issue of leverage looks to be little more than a smoke and mirrors effort to make the real firepower of the fund appear to be much greater than reality.
Turning to developing nations for help. If it wasn't so sad, it would almost be funny. Reports of BRIC participation as EFSF investors have been circulated for weeks. The latest version that reportedly sparked today's market rally:
French President Nicolas Sarkozy plans to call Chinese leader Hu Jintao tomorrow to discuss China contributing to a fund European leaders may set up to bolster its debt-crisis fight, said a person familiar with the matter.French President Nicolas Sarkozy plans to call Chinese leader Hu Jintao tomorrow to discuss China contributing to a fund European leaders may set up to bolster its debt-crisis fight, said a person familiar with the matter.
My goodness, have the Europeans learned nothing from the Americans? Sure, we let the fox into the hen house and didn't have the common sense to chase him out a decade ago. The Europeans are now opening the doors and inviting in the fox. Michael Pettis had a long, must read piece on this topic earlier this month:
In fact the very idea that capital-rich Europe needs help from capital-poor BRIC nations to fund itself verges on the absurd. European governments are unable to fund themselves not because Europe needs foreign capital. It has plenty. They are unable to fund themselves because they have unsustainable amounts of debt, a rigid currency system that will not allow them to adjust and grow, and the concomitant lack credibility.
Foreign money does not solve the credibility problem. What’s worse, what would happen if there were a significant increase in the amount of official foreign capital directed at purchasing the bonds of struggling European governments? Without countervailing outflows, the inevitable consequence would be a contraction of the European trade surplus. In fact if Europe began to import capital rather than export it, the automatic corollary would be that its current account surplus would vanish and become a current account deficit.
The idea on the table is for the BRICs to buy into the EFSF, not struggling debt directly. Even so, they need Euros to buy EFSF debt, which will represent a capital inflow into Europe. The periphery nations are struggling to rebalance internally. The strong Euro is not helping matters. Ultimately, additional capital inflows from the BRICs will only add additional strength to the Euro, encouraging further contractionary external adjustment that only complicates the internal adjustment challenges. The Europeans really should be seeking a European solution, not adding more external stakeholders to the fray.
I guess we should all get some good sleep tonight, as tomorrow will be a busy day.