Thursday, December 3, 2009

Disaster for Europe?

Euro At $1.50 Is 'Disaster' For Europe
France Has Given Its Clearest Indication To Date That The Surging Euro Is A Threat To Europe's Fragile Recovery And Will Not Be Tolerated For Much Longer.
A Sterling Crash Is A Godsend
Ex-FSA Chief Sir Howard Davies Sees 'Dramatic' Risks For Britain
German 'Wise Men' Fear Credit Crunch In 2010

By Ambrose Evans-Pritchard | 20 October 2009

Money to burn: France has said the increasing value of the euro is threatening the economic recovery on the Continent Photo: PA

"The euro at $1.50 is a disaster for the European economy and industry," said Henri Guaino, right-hand man of President Nicolas Sarkozy. The currency has risen 15% in trade-weighted terms since March, equivalent to six quarter of a percentage-point rises in interest rates. It briefly flirted with $1.50 against the dollar on Tuesday before falling back on intervention fears.

What concerns European policymakers most is the lockstep rise against China's yuan. Beijing has clamped the yuan firmly to the weak dollar for over a year, quietly benefiting from the export advantages. It accumulated $68bn (£41bn) in reserves in September alone as a side-effect of holding down the currency. Fresh reserves are mostly being invested in eurozone bonds, pushing the euro higher.

French finance minister Christine Lagarde said it was intolerable that Europe should "pay the price" for a dysfunctional link between the US and China. "We want a strong dollar, and we have reiterated it again in the strongest manner," she said after this week's Eurogroup meeting. China's trade surplus with the EU reached €169bn (£154bn) last year.

Europe and Japan are now the last two blocs standing as everybody else lets their currencies fall, or takes active measures to hold down the exchange rate— with "beggar-thy-neighbour" echoes of the 1930s. Brazil has become the latest country to intervene, resorting to controls to cap the real after its 42% rise against the dollar since March. It is imposing a 2% tax on flows into bond and equity markets. Finance minister Guido Mantega said the move was to head off an asset bubble. Critics called it a "desperate move" that would 'distort' markets.

Hans Redeker, currency chief at BNP Paribas, said the strong real is "eating away" at Brazil's manufacturing base. "They are not willing to take any more of the adjustment burden as long as China and other surplus countries do nothing," he said. Switzerland is openly intervening to hold down the franc in order to stave off deflation. Canada and New Zealand have 'talked down' their currencies. Britain and Sweden have opted for 'stealth' devaluations.

Korea, Thailand, Taiwan, the Philippines, Indonesia and Russia have all been buying dollars to stem their currencies' rises. The effect is to perpetuate the imbalances that led to the credit bubble from 2004-2007 and ultimately caused the financial crisis. Reserve accumulation fuels asset booms because it creates a wash of liquidity and drives down global bond yields. Asia clearly needs to sharply revalue against the West to right the system.

Professor Michel Aglietta from Paris University says the euro is 40% above its purchasing parity of level $1.07 (a low estimate), citing it as the reason why Peugeot and Renault have shifted annual production of one million cars to Eastern Europe since 2004. Airbus is moving plants offshore, building A320 jets in China. It is relying heavily on US contractors for its A350 jet. Fabrice Bregier, Airbus chief financial officer, said the current exchange rate is "becoming very difficult for all industrial companies which have their costs in euros. We can only appeal to monetary authorities to see to it that there is stability in exchange rates."

The European Central Bank could take some of the steam out of the euro by signalling a less hawkish policy. It may be pressured into doing so. EU ministers have the final say on exchange rate under Maastricht, though they have never used this power— publicly. What is missing is a unified front of EU governments.

Italy has been remarkably quiescent, given its export slide. Germany has a higher pain threshold for a strong currency after gaining competitiveness by squeezing wages. But there are limits even in Berlin. The IWK institute says the danger point for German exporters is $1.45. Jean-Claude Trichet, ECB president, has stepped up his rhetoric against "disorderly" currency moves, warning that authorities on "both sides of the Atlantic" were monitoring the markets. He made an unscheduled appearance on Monday to drive home the point. But the body language is changing.


A Sterling Crash Is A Godsend
Britain has twice averted disaster over the past century by a timely— if humiliating— crash in sterling. In neither case was it obvious that this would lead to a decade-long revival in British fortunes.

By Ambrose Evans-Pritchard | 18 October 2009

Commentators told us in 1992 that exit from Europe's Exchange Mechanism would ignite inflation. They misjudged the slack in the UK economy, and the M3 monetary collapse. Cheap Asian exports were, in any case, starting to cap global goods prices. Instead, it opened the way for 14 years of low-inflation growth, the longest stretch of unbroken expansion in UK history. The last phase was bogus, driven by 120% mortgages and Gordon Brown's fiscal blow-off— too loose by 5% of GDP, adjusted for the cycle. But the first decade was real.

The ERM error was not the exchange rate as such. What mattered was the constraint on monetary policy. It forced us to import German rates designed to crush a boom while Britain was in a property slump. Today's events have no parallel, though it is worth looking back at Britain's forced retreat from the Gold Standard in September 1931. The event was calamitous. Gold had been the monetary anchor of the imperial era.

Failure to cut spending triggered the final denouement. The Labour government collapsed. Naval ratings at Invergordon refused to set sail in protest over pay cuts. Events were reported in screaming headlines as a "mutiny". Bolsheviks sang the Red Flag around bonfires. Those reading newspapers in New York, Berlin, and Paris were led to think that the British Empire was crumbling.

Keynes was triumphant, "chuckling like a boy who has just exploded a firework under someone he doesn't like", wrote Skildelsky. Treasury fears of inflation proved wrong. What followed was an industrial resurgence in the Midlands. The 1930s was a rare decade when Britain greatly outperformed the US and Europe. It is why the mood of defeatism in France never quite took hold over here.

France was a mirror image. It had reserves to tough it out on gold, but by doing so forfeited recovery. The social cost rose year after year. Pierre Laval resorted to dictatorial powers to enforce his "500 deflation decrees". Machine guns were deployed against strikers in Toulon; by 1936 the country was ungovernable. Communists took power in the Popular Front. Investors withdrew funds. France was forced off gold anyway. But by then it was a broken nation.

There are such echoes today on the fringes of euroland. Countries trapped in debt deflation with an over-mighty currency— or euro pegs/dirty floats— are receiving the 'Laval' treatment. Latvia is more or less re-enacting the '500 deflation decrees'. Greek conservatives have paid the price for attempting austerity. Hellenic Socialists won in a landslide, with pie-in-the-sky spending pledges. Portugal is limping on with a minority government after voters defected to Maoists and Trotskyists. Romania's government has collapsed, unable to enforce IMF retrenchment.

Irish deflation has reached 6.5%. "We have never seen price falls on such a scale: the illusion that money cannot gain in value is something that must be seriously addressed," said central bank chief Patrick Honohan. Good luck. Politically, these countries face what options traders call "time decay". The longer it lasts, the worse it gets.

Jean-Claude Trichet, European Central Bank president, said this week that "the euro was not created to be a global reserve currency". Trop tard [[too late: normxxx]], monsieur. China and fellow export states increased foreign reserves by $413bn in the third quarter. Barclays Capital says 63% went into euro and yen assets. So the euro trades at 10 yuan, or $1.49 against the dollar, and near parity against sterling.

As long as Asian states hold down their currencies to gain export share, this slow torture can continue— regardless of the underlying health of the eurozone. "The euro is doomed to be strong, unfortunately for them," said HSBC strategist David Bloom. This is not to underplay the gravity of Britain's crisis. We are in a worse state today than in 1992 or 1931. Our budget deficit is 13% of GDP. We are living £175bn a year beyond our means.

Sterling's slide may overshoot so badly this time that it triggers a run on the gilts market. But there are risks whatever we do. My (unpopular) view is that the Bank of England has [so far] saved the UK from depression by printing money a l'outrance [[to the max— outdone only by the US Fed: normxxx]]— and inviting markets to sell sterling.

David Cameron should not have questioned the Bank's strategy so lightly. The only way out is to cut spending as Canada did in the early 1990s and to offset the effects by printing as much money as it takes, for as long as it takes. The greatest error would be to repeat the loose fiscal/tight money policies of Japan in the first part of its Lost Decade, a mix that has driven public debt there to 215% of GDP. That way lies ruin.

A crashing currency is not a pretty sight. Yet the iron rule is that once you have debauched your economy, you must let the exchange rate reflect reality. To do otherwise is to dig your nation deeper into a hole.


Ex-FSA Chief Sir Howard Davies Sees 'Dramatic' Risks For Britain
The British People Are Living In A Fool's Paradise And Have Yet To Understand The Gravity Of The Economic Crisis, According A Former Head Of The Financial Services Authority.

By Ambrose Evans-Pritchard | 15 October 2009

"The next six months are going to be extremely delicate in the UK", said Sir Howard Davies, now Director of the London School of Economics. Britain faces a dangerous rise in the levels of public debt— even taking into account tax increases 'planned' for coming years. "The next six months are going to be extremely delicate in the UK", he told a gathering of HSBC clients in London. "It is very clear that something dramatic has to happen to control spending: but is the economy robust enough to survive fiscal tightening?"

The Government is already running out of weapons to fight the crisis. While the fall in the pound has helped boost exports and proved benign so far, Sir Howard said that past experience handling sterling crises had taught him that matters can turn ugly fast once confidence is lost. "The pound never stops where you want it to," he said.

What is disturbing is that the British people seem unwilling to face minimal belt-tightening. Even professors in higher education are balloting to strike, demanding a continuation of boom-time pay raises. "You have the best minds in the country planning to go on strike for 8%. People are miles away from understanding what is needed."

Polling data shows that 48% of the public are against any spending cuts and only 20% see the need for retrenchment. Britons appear to assume that the "fantastic growth in public spending" over the last decade has become an 'entitlement'. Sir Howard said the reality is that the Government has so far come clean on just half of the fiscal consolidation necessary over the next five years merely in order to stabilize debt. By 2014 we will be among the Big Four of global profligates. "It is not a great club to be in," he said.


German 'Wise Men' Fear Credit Crunch In 2010
Germany's Leading Institutes Have Warned That The Pace Of Economic Recovery Is "Unsustainable" And That The Country's Banks May Face A Fresh Crisis Over The Next Year As Bad Debts Surface In Earnest.

By Ambrose Evans-Pritchard | 15 October 2009

"There is still a significant risk of further shocks to the international financial system," said a joint report by the five 'Wise Men', a panel that advises the government. The 'Wise Men' said Germany's economy would contract by 5% this year. Meanwhile, emergency action by the European Central Bank and authorities worldwide "averted a looming collapse" of Germany's banks over the Winter but lenders are still too frail to renew 'normal' lending.

"Credit to non-financial firms has clearly been declining. Financial conditions are likely to worsen further. Banks are facing large write-offs on toxic debt and a rising toll of company insolvencies," it said. The report said it was a serious error to pressure banks to raise capital ratios in the middle of a downturn, causing them to tighten lending standards. "There is a major danger that already tight financing conditions could lead to a credit crunch next year," it said.

The first round of the financial crisis hit the big banks and state Landesbanken, which had portfolios based on US sub-prime debt and other 'tradeable assets. The next wave of victims may be the country's savings banks faced with the 'slow-burn' losses of [['non-tradeable': normxxx]] loan defaults. Large companies can raise money on the bond markets but smaller Mittelstand family firms are facing serious problems rolling over debt. Germany's industrial lobby VDMA this week called for a change in policy to prevent savings banks from choking off credit to its members, the backbone of the export machine.

The 'Wise Men' said Germany's economy would contract by 5% this year. They have upgraded their growth forecast for 2010 from minus 0.5% to plus 1.2%, but cautioned that unemployment will rise by another 300,000 as firms pull back from costly work-support schemes, known as Kurzarbeit. The pace of the current rebound— driven by restocking and short-term stimulus— is "not likely to be sustainable".

The report said Berlin had botched its bank rescue programme by allowing lenders to choose whether to take part. Banks opted to cut lending rather than dilute their share base or accept onerous conditions from the state. They were reluctant to send a "negative signal" to the markets by admitting to distress.

Separately, the rating agency Moody's said this week that Spanish banks face "severe asset quality deterioration" and have yet to make provisions for over half of the €108bn (£99bn) of likely losses over the next five years. The figure could yet prove much higher if the pessimists are right about the gravity of the Spanish slump. Under Moody's "stress scenario" losses could reach €225bn.

"Spanish banks have so far demonstrated remarkable resilience, but Moody's remains concerned that many entities appear to be avoiding recognition of the true scale of asset quality deterioration on their books," said analyst Maria Cabanyes. The Bank of Spain has been praised for trying to restrain credit by tightening lending standards as the boom gathered pace over the last year. This has bought the country some protection. However, the effects of ultra-low interest rates in the eurozone washed over their best efforts.

The Bank has since admitted that monetary policy set in Frankfurt was too loose for Spain's needs over an extended period.

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