A hypothecation of a politically palatable German policy regarding the euro

naufalsanaullah's picture

More developments from the Germany vs EU drama: http://online.wsj.com/article/SB10001424052748704638304575636580416827208.html

The EC (executive body of the EU) wants to double the EFSF (European sovereign bailout fund) to mitigate market concerns that it is insufficiently large to deal with issues from Spain and Portugal. Germany, of course, is sick of paying for the losing debtors in the failed EMU experiment and has in fact exacerbated the Irish crisis by the timing and severity of Merkel's comments regarding the inclusion of bondholder haircuts in any permanent debt resolution mechanism.

My take is that Berlin will eventually relent to EU contagion risks via the intermediary of the Bundesbank, and Weber will get the go-ahead from Merkel to give the go-ahead to Trichet to begin a bond purchasing program (Q2-Q3 2011 is my guess for timeframe), bringing the ECB to joining the ranks of the Fed, BoJ, and BoE in instituting QE. Germany is very anti-inflationist, given the Weimar hyperinflation of the 1930s and its role in causing the rise of Hitler and eventually WWII, but its export growth model is facing twofold headwinds from opposing CB easing programs diminishing competitive advantage as well as overall global demand destruction hurting export aggregates, so a selloff in EURUSD would probably be welcome from Berlin, especially if/when growth data shows Germany's economy slowing down (which is inevitable once the EURUSD rally from 1.19 to 1.42 gets discounted into economic data/figures, most likely Q1-Q2 2011).

From there, Berlin can experience a huge export-driven economic boom while simultaneously selling euros, eventually eliminating contagion/systemic-level exposure and beginning domestic currency NDFs once EURUSD plunges to crisis levels, at which point Germany can start blaming the periphery for ruining Germany's own monetary system and going against the Maastrischt Treaty's and cultural German demands and guidelines regarding inflation and currency stability, particularly politically pragmatic considering the already-existing and increasing rift between Germany and the periphery because of the sovereign debt crises. This would be the first step in Germany leaving the EMU and thus the euro.

As noted by Simon Johnson and the FT, what Greece represents is the modern-day, sovereign version of the Creditanstalt crisis moment in 1931, and thus Germany needs to distance itself from the rest of Europe's monetary policy with a strict sense of eventuality. However, that does not mean it cannot be opportunistic to gain both economic advantage and political capital by timing its departure, as well as create the conditions because of which and context within which it reacts, from the EMU and its currency.

As I've said in previous pieces, TMM bring up a very interesting point in noting that G7 sov CDS are not triggered by redenomination. The race to debase is very much on and growing, and this situation is providing the ECB with the justification for entering the QE rush, and with the BoJ now wholly defeated by the markets and the Fed's second iteration discounted in markets ahead of a likely sharp contraction in growth in mid-2011 due to fiscal consolidation and state/muni funding crises, the ECB and BoE easing programs will likely be the most significant driving forces at the margin as far as central bank policy in the first half of 2011. As such, EURXXX and GBPXXX crosses are likely strong candidates for sharp selloffs for the next several months, and I like CAD USD & CHF as the currencies to go long against these shorts.