The Day After

May 11, 2010

Market movement since the euro area rescue package leave me less than overwhelmed.  Writing yesterday in Larry’s Blog, I compared these measures to the November 1, 1978 dollar rescue package.  The centerpiece of each of these initiatives was a war chest of resources that would be available to reverse undesirable market moves and then to stabilize markets against future speculative waves.  Both packages lacked adequate changes to address the underlying economic imbalances that was causing disorderly market conditions.  The 1978 dollar rescue was ultimately unsuccessful, and the dollar did not rise in a sustainable way until after the Fed adopted a monetarist policy. 

In the first week of November 1978, however, markets did reverse in very electrifying fashion.  From a low of DEM 1.7030 in Asian markets early on Wednesday, November 1, the dollar rose 4.6% to DEM 1.7815 by the U.S. open, by 9.5% to DEM 1.8650  by the open on November 2 and by 12% to DEM 1.9065 by the open on the following Monday.  The announcement on November 1 promised to use the war chest to fund intervention, and follow-through dollar buying began immediately, reinforcing the signal that officials were determined to write a new chapter for the dollar.

The day after yesterday’s unveiling of a contingency package of resources to prevent any sovereign debt problem from unraveling has not seen officials putting their money where their mouth is.  On the contrary, market participants have been left to agonize over many festering aspects of the problem.

  • How will Euroland’s peripheral economies restore sustainable public finances when the tremendous austerity that must be now imposed drives these economies deeply into recession?  They have no means to rebuild competitiveness.
  • Will politicians in all of Euroland’s nations agree to the terms of the deal?  What happens when interest groups in affected nations next riot in the streets?
  • Isn’t this plan seeding even more moral hazard?  Reckless behavior once again has been bailed out with taxpayer money.
  • The ECB has always prided itself on being a beacon of stability and predictability.  The central bank’s purchase of public and private debt is exactly what officials up to and including last Thursday’s policy meeting kept refusing to consider.
  • The ECB is known for consensus decision-making in which dissenting opinions are not aired in public as Bundesbank President Axel Weber has done.  He is not just a single voice among many on the ECB Governing Council.  He represents the German Bundesbank, Europe’s policy-setting central bank before the age of the euro and the ancestral DNA-provider of the ECB.  As the the largest and most prosperous member of the euro area, Germany will fund a larger share of this package than any other country in the region.  The financial press today is full to stories that this kind of resource transfer is exactly what German voters had to be convinced could never happen when they reluctantly agreed to join the European Monetary Union.  The word betrayal comes to mind.

Stocks and the euro are two places to gauge how impressed and comfortable investors are with the EU initiative.  The German Dax closed today only 0.3% higher than yesterday.  While holding onto a 5.7% rise since May 7, the Dax remains 5.4% lower than on April 26.  The euro touched 2010 lows on May 6 of $1.2518, JPY 110.5, Chf 1.3991, and 103.32 on a trade-weighted basis.  At 18:00 GMT today, the euro showed declines from yesterday’s U.S. closing of 0.5% against the yen and Swissy  and of 0.4% versus the dollar.  It was only 1.7% and 0.9% stronger than its May 6 lows against the dollar and Swiss franc.  On a trade-weighted basis the euro fell 1.2% today and was even 0.1% lower than its May 6 level.  At its new low, the trade-weighted index has lost 10.4% since last October 26.

Market conditions forced Euroland finance ministers to act in the wee hours of this past Monday.  They didn’t have proper time to prepare immediate follow-through actions.  Officials intended to put themselves ahead of the curve with the EUR 750 emergency funding package, but have not hit the ground running following that announcement.  Instead of news headlines today describing budget cuts passed by politicians in Greece, Spain, and Portugal, market participants are learning about all the unfinished business and the internal disharmony that plagues the euro.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



Comments are closed.