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Devalue the Euro?
Holy smokes! The EU technocrats have finally pulled out the big guns! The agreement on Friday was to take the incredibly bold step of avoiding subordination in the Spanish bond market. The money needed for the busted Spanish banks will now be made available directly from Brussels with few strings attached. Wow! What a breakthrough!
Global markets have taken a quick look at what has been offered up by the deep thinkers in Euroland and said, “WE LOVE IT!”
Me? I think it’s a spit in the bucket. The half-life of this bailout will be measured in weeks.
We have seen this play out time and again the past four years. The capital markets are forcing policy decisions.
“Wise” people like Paul Krugman have said for years that “Bond Vigilantes” don’t exist. There is no doubt any longer that they exist and are alive, well and hungry. The vigilantes are also armed with highly sophisticated robots that can execute attacks on multiple fronts and across markets in milliseconds. The war going on in the bond markets is not over by a long shot.
My read of the EU summit is that Spanish banks are going to get a “soft” bailout. Existing common shareholders and subordinated bond holders will not get wiped out (as they should). The bankers must love this result. They get to keep their jobs for a few years longer, all the time praying for a miracle.
Where does this go? Directly to Italy. Which Italian bank would love to have some of that cheap equity money that Brussels is doling out? All of them.
But here’s the deal, France’s banks are in desperate need of new equity too. They have been selling off assets left and right. That’s no way to keep up employment in Socialist France. There are some very big balances sheets in Paris that need a new slug of 3% Perpetual Preferreds. If Italy’s banks get the "Sweet Deal," then the French banks will have their hands out too.
Talking about re-caps of banks in Spain, Italy and France, we might just as well include a few dodgy banks in Brussels. A couple of German banks are also thin on equity. Add a few of them to the list.
Ah… I’m sorry to rain on the parade, but the number derived from all that bailing starts with Euro 1 Trillion, and could easily push to E2T.
Where is this big sum of money coming from? A three-letter entity that doesn’t really exist yet? One whose charter requires votes from EU countries? The “savior” that is going to do the trillions of bank-bailing actually doesn’t have a penny to its name.
And can I ask someone about the timing of all these things getting sorted out? Look at the calendar. Europe is on holiday. See you in September before any of this is inked and the money is flowing. The vigilantes are not on Vaca.
If I'm right, after a few weeks things turn south again in the capital markets. Then what?
- More LTRO. No – there is no more collateral. All of the swill loans have already been hocked.
- Cut ECB % rate. Doesn’t matter. It won't change conditions in Italian or Spanish funding markets one bit.
- A spending plan of <1% of GDP. That won’t put a dent in the recession that is building.
- Brussels buys more sovereign bonds to avoid a catastrophe of Italian 10-year exceeding 7% (capitulation). Sorry. There are “wise men” in Germany who will simply not allow this to happen in the scale that is required.
- The ECB goes Defcon 1 and launches a E2T QE program. No – same answer as above.
- Merkel does a 180 and embraces Euro bonds. No chance in hell.
-The US or China are going to start buying EU bonds? Lunacy – not happening.
-The IMF will come to the rescue? No way – the IMF does not have the resources to solve anyone’s problems.
There are more bullshit things that could be added to this list, but they either will not work, or are too politically unacceptable to happen. If the steps taken on Friday fail to stem the crisis beyond a few weeks, what else is on the table for consideration? The answer is that whatever may be coming, it must meet the following criteria:
-must be able to be implemented in a very short period of time (e.g. a Sunday night announcement).
-must have a global component. Europe does not have the resources to address the problems it faces alone.
-can’t be subject to political approval. That process takes too long, and the politicians can’t agree on anything of substance.
What policy steps meet these requirements? There is only one. The next significant step out of Europe will involve changes in FX rates around the globe. A number of possible currency steps have already been discussed, including:
1) Peripheral countries re-establish their legacy currencies. Spain will reintroduce the Peseta, Italy will bring back the Lira etc.
2) The Euro is split in two. There would be a Northern and a Southern Euro.
3) Germany leaves the Euro and re-establishes the Deutche Mark.
These are possible outcomes. But I consider them to be unlikely. Too much effort has been taken to create and preserve the Euro for the deciders to throw in the towel anytime soon.
There is one currency option left. Devalue the Euro by 20++%.
This would make a difference. It would go a long way towards stabilizing the real economies of Europe. It would create inflation, something that is sorely needed to devalue the real size of Europe’s debts. Germany would agree to this as it preserves their export-competitive position within the EU, and improves it outside of the EU. The technocrats in Brussels would love it; it’s the only thing left that would preserve the monetary union.
Is this feasible? I say it is. It has happened twice before in history. In 1985 the world got the Plaza Accord that devalued the dollar and in 1987 we got the Louvre Accord that revalued the dollar. In both cases, the global central banks (CBs) and acted together.
With Plaza Accord, the CBs made a joint announcement on a Sunday evening that they would be selling the dollar against major currencies until such time as a meaningful devaluation had been achieved. It worked.
A devaluation of the Euro (versus the Yen, Sterling and the Dollar) would be approved in Brussels in a heartbeat. Germany would be reluctant because of the inflationary implications, but it would reap the benefits of a cheaper currency too. The USA and China would absolutely hate to see a devaluation of the Euro. It would hurt their respective economies. But the deciders in China and Washington also know that a complete breakdown of the EU economy would lead to a global depression.
The timing of something like this is critical. Would Obama instruct the Treasury Department to intervene in the currency markets (via the Federal Reserve)? He would, if it happened in the next few months. The consequences would not be felt, in a meaningful way, by US exporters until after the November election. Obama also understands that if the EU goes belly up before the election, his chance of winning goes down. If the EU tanks, so will the S&P.
China and Japan would have some say in this in order for it to be successful. The CB interventions would have to be coordinated. If the UK and US go along with it, then Japan will be forced to join in.
China is a wild card. If China participated, it would be devaluing its own Euro reserves. It would cost China a few hundred billion dollars. But it would cost China far more if the EU went into the crapper for the next five years.
I’ve been out of the FX markets lately. I’ve been concerned about “event risk”, where something is accomplished in Europe that actually made a difference. I think that this kind of event risk is now behind us. I bought some puts on the Euro Friday afternoon. We shall see.
The idea of a coordinated central bank response ala the Plaza and Louvre Accords may seem far-fetched. But tell me another option that has a chance of working.
What is the “fair” value of the Euro? Whatever the central banks want it to be. Is the Euro over valued today? Visit the EU and make your own judgment. I say it is. The following articles go a long way towards answering the question of the Euro’s value versus the dollar. When EADs puts up $600m to build a manufacturing facility in Mobile Al., you know the Euro is over-valued.
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Given what is happening in Europe these days, I'm surprised that Airbus is doing this. Places like Spain could use the $600m investment in plant, equipment and jobs that goes with this. Good for Mobile, not so good for Europe.
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Um... wait... won't coordinated Euro intervention create massive FX risk for the world's CBs?
Switzerland is sitting on a bomb, no? If the Euro goes down 20%, what happens to all the Euro sitting at the SNB? Does the SNB become insolvent?
I can think of a much simpler way the crisis gets fixed - and it hinges on the fact that Merkel is already besieged - surrounded by the SPD/Green German left and the Latin bloc Left.
What will happen is that the ECB will assume LoLR status along with running the (already agreed as of Friday) EU banking supervisor. Why? Because it "just makes sense". And then it will be empowered to run a massive Twist - buy periphery, sell bunds - ECB will forcibly converge the yields and sit on a massive (paper) profit - no threat to its solvency.
Massive new supply of freshly printed Euros, and the "market equivalent" of Euro bonds (converged yield) without actual Euro bonds. Euro may surge for a moment but will crater when the impact of printed Euros is felt.
Problem solved (for the same "few years" as Bruce's scenario).
EU will agree to Fiskal Kompact so that what remains of the German right will have saved some face, but that will be a fig leaf.
Bruce may claim the "wise men" in the ECB will forbid this but I only pay attention to genuine signals of power and the signal from the summit is that Germany has no power. The issue has been forced and there is no reason to believe it will not be forced again, against whoever stands in the way.
Everything will likely unravel again in the next few years, but in the meantime the Krugmans of the world will claim vindication, the charts will show "growth" (really price driven impoverishment, but who's counting) and the Left will be firmly in control, having purchased what's left of the private sector with printed money, and having made welfare vassals out of the remaining free peoples.
If you're a Left-consensus technocrat, what's not to like? And oh yeah, no cooperation from the rest of the world required.
What I think will happen is that part of the coordination would be for Germany to go back to the Mark at the same time. After the devaluation they would then come in and support the EU, Euro, SNB, etc. along with the Fed. In my view this would be the best approach. Face it Germany is really the outlier in the EU economically. Possibly the Netherlands but none of the other countries square up with Germany in many ways at all.
Forgive my ignorance - but isn't the bond market as easy for the TPTB to manipulate as the equity markets? This is not my area - but wouldn't the entire focus of central bankers now be to hold German bond yields down at any cost?
What prevents Germany from leaving the Euro, and printing Marks until it trades at a compromise between maintained savings and maintained competitiveness? That would be more politically acceptable methinks.
What prevents it? Simple, a so-called leader without cochones... she created words such as "Alternativlos" (without alternatives), that's what is 'leading' Germany, a simple follower of Brussels.
I think devaluation of the Euro would only be acceptable once Germany took on too much risk and had 7% interest like everyone else. Destruction of the hard-earned German savings will wreck Merkel.
Destruction of much of the hard-earned German savings is already a given, I think. At least whatever has been leant to many of their European neighbors.
Might as well suck it up, take their losses and start over.
the destruction of that wealth is already there but not OVERTLY recoginsed as such; its in the bigger banking balance sheets of first world and in the smaller state balance sheets of the same. With a 300% private debt to public sector gdp, a 90% public debt/GDP ratio, continent wide, we are already without wealth; only we don't know it!
Yes, flushing out the funny money, destroying 25 T of first world Oligarchy money and resetting to new paradigm is the true route out. But TPTB do not want to commit collective financial suicide, they prefer that the 99% of first world die slowly by a thousand cuts.
And for the encore? This would solve all of none of the structural problems in Europe, it would buy some time. However, what happens when the US or China feels a slowdown? If they resorted to the same measures then all that happens is a pretty much global loss of purchasing power. I'm not saying this won't happen, as I more or less expect global Wiemar. But it's not a solution, it' just more of what we have been seeing, kick the can.
Devaluation would make QE3 a certainty.
When the US central bank embarks on a massive bond-buying spree, it injects a massive amount of liquidity into markets, and this drives US and global stock markets higher. Some of this extra liquidity also comes over into commodity markets, pushing up prices for goods such as oil and gold.
To state the obvious, after the Fed’s QE2 – wholesale gasoline prices rose by more than stock prices, and other commodity prices saw big jumps.
The trouble is that many small and medium-sized US companies see their profit margins squeezed when prices for oil and other commodities rise steeply. And when households are forced to spend more buying petrol for their cars, or on heating their houses, they have little choice but to cut back their spending on non-essential items. Because it pushes up the cost of living, QE actually undermines the living standard of millions of low- and middle-income households in America.
i dont think Bernanke really cares though
Agree Bigduke if the Euro probably goes below 1.15 peg the Fed will print. I think this is what is holding up the next QE. Oh and the elections as well.
How do you devalue something that is freely floating?
Do all the players sell Euros and buy something else until an equilibrium emerges (if it does)?
Or are you suggesting the Euro become non convertible like the Chinese Remnimbi - or Argentine Peso?
You devalue it by printing as much as required ( € 2T ??) to buy $, yen, RMB, pounds, etc and drive the value down to the target levels. The recipients of all those newly printed Euros will have to put them somewhere, and that means EU sovereign bonds. Where else can those Euros ultimately end up? Euros only exist on the books of the Eurosystem, and have to end up somewhere in that system. Devaluation IS QE.
Yes. And equilibrium will emerge on the word of the central banks. Since currencies trade on the basis of supply and demand, the central banks can set any exchange rate they want. However, everyone thinks devaluing the Euro would allow Europe to steal growth from everyyone else. In that case it wouldn't be long before everyone devalued; Buy gold.
Remove capital flight controls and that 20%++ correction will take care of itself.
The MACRO story of Europe’s depraved depletion because there is a Great Depression lack of Money, rhymes well with two MICRO stories of today in East Texas.
I bought a tractor in the beautiful wooded country of central east Texas this morning. The seller recently was laid off at ATT and has been selling mobile homes. He is doing well at selling them but financing is as hard to find as a honest politician. So, he is going to have to do something else. My recently acquired friend who is picking up the tractor for me tomorrow, was working at one of the largest daily news papers in the south. Because he was in upper management, he had access to the numbers. Because of the negative picture he saw, he left his job and started a tow business. He is doing very well. But the negative part of doing a good job and folks liking him is that there is an offer by a couple of entities to grow the business. SOooooo, to do that he need a buck or two to buy a couple of pieces of equipment. He can tell you were the money is not to be found. He will gladly tell you if he finds some. He is going to make it, in spite of the chaos of Financial and Government actions and inactions. I am sure the tractor seller will find something, hopefully. The tractor I bought will be going to Viet Nam. I will only clear a couple of hundred but that is better than nothing. I missed a good tractor buy Wednesday, because it was sold to Egypt.
Remember the advertisement---“this is not your father’s Buick”----- well, it is not your father’s economy nor his government. It is also not your father’s World. Nor is it yours or Americas. We are a third world country now and you can either like it or lump it, because there does not a appear to be a whole hell of a lot that you can do about it. but I, for one, am not ready to surrender just yet
There are huge yards on the Houston ship channel filled with yellow machines, all bought at auction (like Richie Bros) and headed for (mostly) China. So says a guy that owns one of the yards. Has been going on for years, picked up steam after crash. The US is being slowly liquidated. China is piling up capital equipment, gold, oil, minerals, etc to the sky. Modern economists call it excess or oversupply, sounds like "riches" to me.
Resources and intellectual capital are fleeing the country. Worthless shit is replacing it.
I particularly loved the G.E. ad for Electomotive train engines where G.E. American employees are running down a path to watch a Buffet Train go by Lake C'oeur d"alene Idaho. As the camera panned away from the locomotives, an entire container train was rolling by, full of Chinese shit.
The irony must have been lost on the head-in-the clouds G.E. boys.
What a country !
In the 30's every piece of scrap metal not in use got sold to Japan. A lot of it got fired back at us.
Proposed bailouts half lives have become days, not weeks or months.
There is no free lunch
The Law of Unintended Consequences has yet to be repealed.
Somebody will fuck it up.
Krugman will try to take credit.
Another topic for ZH ridicule.
Who cares.
This is nothing new.
Dontcha just love the BS.... "Contagion"
It's not the complete financial and economic demise of an entire continent.
It's a fucking sneezy, sore throat, runny nose the kids caught at school.
They even act like its a fucking common cold.
Jesus...
This is probably easiest way out for the Euro-politicians.
I'm sure the labor unions in the EU will immediately be asking for 20% wage raises, too.
It is inconceivable that the EZ could undertake a devaluation of the Euro without the blessing and cooperation of the US. And it is inconceivable that the US could allow for a significant strengthening of the US$ as this would both put a stake in the heart of US export competitiveness as well as add to significant deflationary forces here at home. I understand the race to the bottom dynamic, but I don't believe that the US has any intention of losing this race!
We've already seen plenty we didn't expect
BK's point about the election is sound. Obama and Bernanke will do it to get past the election only. They can't afford for Europe to lay an egg that makes US unemployment numbers go up before Nov 6. After that, all bets are off.
Admittedly, I'm no guru, but common sense tells me another few years would be a stretch. Then again, what do I know?
inflation with a devalued >20% devalued Euro. Not a chance, with the recent EUR/USD strength, inflation has gone down in the Eurozone, with 20% more value for the USD, that leaves energy company asking for bailouts from the Democrats, of all people. With USD strength, there goes large multinationals earnings. A big hit on earnings. Gas back below 2.5/ gallon more than likely as well.
If announced on a Sunday night with no warning, a 20% devaluation of the Euro would send the correlation bots into a tizzy, and the S&P could end up in an total reflexive crash.
EUO
https://www.google.com/finance?client=ob&q=NYSEARCA:EUO
Amazing everyone hasn't heard about the problem with ultrashort ETFs...
a Euro devaluation could really hurt the UK couldn't it?!
Agreed though Bruce - it isn't so far fetched at all.
The only solution to the currency wars is for the Western countries to get together in a bloc and declare a fixed exchange rate and live with it. This exchange rate would value the currencies of China, Korea, Taiwan, and Japan about 40% higher. If this is not done the Western powers are toast.
The only real solution is to dispense with all of the games, deceptions and back stabbing, and eliminate the fraud by eliminating the central bankers and the fiat money.
Use real money, such as gold or silver, and bring every country's economy into conformity with reality. Fix the stupid rules and regulations. Allow the free market to help bring wages, pensions, benefits, prices etc. into alignment with that reality.
And what about the SNB's 1.20 peg? Would they still try to defend it against the rest of the world? Couldn't happen...
Perhaps the whole fucking scheme will come completely unhinged 12/21/2012
I hope so. This needs a complete clean out.
DavidC
it is a race to the bottom
European companies are always stating that they'll move their production offshore. It's a threat that seldom occurs because it is a bargaining position to get concessions from the Socialist governments in Europe. When the German government passed a number of horrible employment laws Daimler (Mercedes) purchased Chrysler and declared it would move its headquarters to New York City. The German government backed down.
I would think so. The other central banks probably see the need to give a virtual haircut to all of the bondholders and that would be a quick way to do so. But I can't see all of the other central bankers allowing the Euro to drop that much relative to all of their trading partners. Come to think of it the U.S., UK and Japan have been downgraded too and have untenable debt loads hanging over their respective economies. China's an export driven economy and is already hurting significantly due to the ongoing financial crisis so they won't be willing to in effect revalue their currency upwards by 20% or whatever.
The politicians will invariably move towards the path of least resistance, and none of them want to let their trading partners devalue their currencies relative to their own. Seems to me like they'll be pushed towards the only "solution" that might seem to work as a deus ex machina...
DOWNGRADE ALL FIAT CURRENCIES!
A worldwide economic reset.
Of course it would involve some pain and would only kick the can down the road for everybody, but when your back's against the wall, anything that will buy some time will look mighty inviting.
Beggar your neighbor redux
Bruce, I may be missing something here, but how can 'they' devalue the euro without QE? Back in the 70's, they were able to devalue the dollar by selling them because so many dollars were held by foreign central banks (the legacy of Bretton Woods). I know the euro is now considered the 'second' reserve currency, but do foreign central banks hold enough of them to be able to sell them off sufficiently to engineer a 20% reduction in its value?
Furthermore, the main problem here is solvency. There simply aren't enough euros out there, moving fast enough, to pay down the debt. Devaluing the euro will bring price inflation, sure, but not the outright monetary inflation required to pay down the debts via monetisation. If the inflationary aspect of devaluing of the euro is sterilized by it being brought about by selling existing euros, I fail to see how it will make the debt easier to be serviced.
Yes, their exporters will pick up some steam, but at the price of local buying power being diminished. Exporters will gain, but companies selling to local markets will be hit commensurately. I might add that the US' dollar devaluation in the 70's didn't help the economy, and that was genuine monetary inflation - all those dollars that had been circulated and were no longer redeemable for specie came home. It took Volker to fix that... and he certainly didn't do it by devaluation :-)
Furthermore, much of this debt was created via fractional reserve banking. If it's paid down with sterilized money, won't monetary aggregates shrink, compounding liquidity issues throughout the eurozone?
I just can't see how they get out of this pickle without more QE. Or collateralizing more actual stuff... like the Parthenon (or, indeed, outright selling off of stuff to the creditors. Here's our railway system! Here' 50% of all 'publicly'-owned land! etc).
Love your posts, by the way. But I think this one needs more examination, or, at least, more explanation.
Bruce: Presumably the US-dollar price of gold would drop at first, in response to a Euro devaluation, but do you think that would be it, or would there be longer-term implications? Thanks. Great piece.
Dollar would rally and the price of all commodities would drop.
IranWar sustained oil price spike/dollardump will kill the dollar, briefly strengthen the Euro, then it'll crash too. There's no time left for any more shell games. 50 days to economic, political, perhaps military Armageddon. Invest in lead, Bruce, not currency.