Markets Doomed to Be Always Waiting for Something

June 24, 2015

For the record, the past statement week from Wednesday to Wednesday was a good one for the dollar, which appreciated at two speeds.  Advances of 1.4% to 1.8% were clocked against the euro, Swiss franc, Canadian dollar and New Zealand and of 0.7% were accrued against the yen, Australian dollar and sterling.  The dollar’s strength was fed by changed expectations that undoubtedly will change again and again and again. 

The clarity that investors seek on a bunch of key uncertainties remains forever elusive.  Foremost this week has been the fate of Greece within the European Monetary Union and beyond that what will become of the common currency area, the broader European Union, and even the North Atlantic Treaty Organization.  Markets are focused on the short term because of the possibility of a Greek default at the end of this month and Grexit by end-summer unless a deal can be worked out between Prime Minister Tsipras’ government and Greece’s troika of creditors.  Odds of this likelihood have been changing by the day, even by the hour.  Markets are positioned mostly for an agreement but hedging against the possibility of no deal.  Opinions differ on the likely repercussions of default, and the uniqueness of the circumstances make the correct answer a mystery.  Whatever happens over the balance of June and this summer, the euro now more than ever appears to be an ultimately doomed currency.  Economists in the 1990s widely advised against locking Europe’s national currencies into a single money with a one-size-fits-all monetary policy but without a consolidated fiscal policy.  The project went forward anyway to meet goals of foreign policy and for a few years worked better than imagined.  The post-Great Recession period, however, has justified the initial qualms about irreconcilable cultural differences that would never be bridged, and the error of the project was multiplied infinitely by designing EMU in such a way that members leaving the common currency cannot do so without inflicting enormous harm on themselves and the whole region.  One way or another, the common European currency bloc faces a cataclysmic backward step to the future, maybe not this year or even next but probably sooner than is generally appreciated. 

The second most pressing uncertainty du jour is how the U.S. and other economies react to the normalization of monetary policy.  Quantitative Fed stimulus has already ended but not yet been reversed.  The next step is to be a data-driven, gradual rise of the federal funds rate.  If economies cannot handle that process, it may go no further than a single hike.  In other economies, like Japan, attempts to raise interest rates from zero were not been received well by markets or the real economies.  It’s worrisome that potential growth rates fell sharply this century in the advanced economies.  A second ominous development is that demand in developing economies like China, which played a key locomotive role during the Great Recession and in the ensuing recovery, is rising much more slowly now, and a third is that the sub-par U.S. recovery so far has relied on the crutch of zero interest rates.  In the coming normalization of Fed policy, data will be steering Fed policy, not the will of some or all members of the Federal Open Market Committee.  So when Governor Powell opines that the first rate hike ought to be in September and that a second increase seems preferable before yearend, he’s assuming the response of the economy and markets will be tolerable, but he in fact doesn’t know if that will be the case. 

Churchill in 1947 argued that “democracy is the worst form of government, except for all those other forms that have been tried from time to time.”  The 21st century has tested that thesis both for countries that have long had democracies and in places with some form of command authority.  Ideological stalemate, poor judgement, and delayed action on the critically important issues of the day plague politics in Europe, Japan, and the United States.  Efforts to plant democracy have foundered in Russia, the Middle East, and parts of Africa and Latin America.  No country is prouder about its brand of democracy than the United States.  But since the U.S. trails well behind world leaders in numerous quality of life measures such as life expectancy and income inequality while leading in less desirable criteria such as jailed citizens and share of GDP spent on healthcare, American exceptionalism is acquiring a more pejorative connotation even as the dollar remains basically unchallenged as the world’s dominant reserve currency.  The greenback has been so distinguished since the end of the Second World War.  For the past year, it’s also been well bid against gold and other paper currencies.  That being said, the market’s vain search for less uncertainty on some big matters in a rapidly changing world make one wonder about permanence of today’s financial world and the dollar’s central place in such.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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