Thursday, May 12, 2011

Paradigm Lost...

...a continuing series. The funding assumptions that I have discussed on this blog on numerous occasions remain an intellectual null zone for "mainstream" economists. The below article from today's FT demonstrates this once again. Sovereign issuers do not need "loans" to get "money" to pay interest or principle on debt. The desire for the world to NET SAVE U.S. financial assets is completely rational given the geopolitical and institutional framework existing at this epoch in history.

This assymetrical fetish emphasizing net exports and "debt" levels is counterproductive to understanding what the world instructs anyone willing to look. The more officials in the Euro area in particular misapply these assumptions, the more they are forced into History's classic re-booting mechansim for governments, currencies, bonds, and sovereign nations: War.

By Axel Merk
Published: May 11 2011 13:31 | Last updated: May 11 2011 13:31

Imagine a country that spends and prints trillions to patch up any problem.
Now imagine another country where there is no central Treasury, meaning that bail-outs are less easy, and which has a central bank that has mopped up liquidity over the past year, rather than engage in quantitative easing.
Why does it surprise anyone that the latter, the eurozone, has a stronger currency than the former, the US? Because of peripheral countries’ debt refinancing issues? And the potential for contagion? These are real and serious issues, but in our assessment, they should be primarily priced into the spreads of eurozone bonds, not the euro itself.

Think of it this way: in the US, Federal Reserve chairman Ben Bernanke has testified that going off the gold standard during the Great Depression helped the US recover faster than other countries. Fast-forward to today: we believe Bernanke embraces a weaker currency as a monetary policy tool to help address the current state of the US economy. What many overlook is that someone must be on the other side of that trade: today it is the eurozone, which is experiencing a strong currency, despite the many challenges in the 17-nation bloc.

A year ago, the euro appeared to be the only asset traded as a hedge against, or to profit from, all things wrong in the eurozone. This was partly driven by liquidity, because it is easier to sell the euro than to short debt of peripheral eurozone countries; and as the trade worked, others piled in. As the euro approached lows of $1.18 against the dollar, the trade was no longer a “safe” one-way bet and traders had to look elsewhere. As a result, the euro is now substantially stronger, yet peripheral bond debt is much weaker.

The one language policymakers understand is that of the bond market. A “wonderful dialogue” has been playing out, encouraging policymakers to engage in real reform. Often minority governments have made extremely tough decisions. Ultimately, it us up to each country to implement their respective reforms; political realities will cause many to fall short of promises, resulting in more bond market “encouragement”. Policymakers hate this dialogue, of course, but must respect it.

Any country may default on its debt. The problem is that it may be impossible to receive another loan, at least at palatable financing costs. Any country considering a default must be willing and able to absorb the consequences, which is an overnight eradication of the primary deficit.

No comments: