Notes From Underground

As readers of NOTES FROM UNDERGROUND are well aware, this blog takes over from where the econometricians and model builders fear to tread. Case in point: The current Irish DEBT problem. All of the number crunchers are straining over whether the Irish Banks or the government is the biggest problem and if it’s a solvency or liquidity issue. Neither!

Europe is feeling the impact of Germany’s anger about having to bail out its profligate Europeans. I am not going to engage in the discussionabout how Europe’s problems ultimately stemmed from rates being kept too low and the EURO too weak when it was Germany that needed an economic transfusion at the turn of the century, for that is an old story. It is now that Germany is economically strong after having frozen wages and lived under an austere budget while Schroeder’s Hartz IV was the rule of the day. It was, of course, easier for the Germans to be austere for the rest of the world was growing strongly, so the pain was lessened.

The fact is, as I have discussed ad nauseam, the German citizens don’t want to transfer their wealth to bailout those who lived well beyond their means. This is just not politics but also a matter of law for the basis of Maastricht was that there would be no bailouts for defaulting European states and the German Constitutional Court has implied that it would hold to that stringency. Chancellor Angela Merkel is feeling the heat as political pressure builds as even the mainstream media has taken her to task for earlier compromises on the Greek government “bailout.” It has gone so far that Merkel took out ads in today’s major German newspaper, and, in an open letter played to the German psyche by letting her fellow citizens know that there is no German economic miracle, but rather just success from “their good ideas, their good sense, their can-do attitude.” Frau Merkel is letting the German people know she is proud of where they have gotten and this is playing to her hardening stance in having bondholders share a part of any debt restructuring.

Negotiations are going to get tougher as the Irish are also toughening their stance and don’t want European funds. The Irish maintain they have enough money for another nine months or so and they will try to tighten up even more so as to not need funds. Irish politicians are afraid that the price for European funding will be a demand from Brussels that the Irish state raise its corporate tax rate from 12.5% to a much higher level to help stem the budget deficit. Ireland’s corporate-friendly tax rate was greatly responsible for the “Celtic Miracle” and raising taxes on business at this critical time would do more harm than good. Many Eurocrats in Brussels have despised the low tax areas of the EU and have actively pushed for tax harmonization. This is presently the greatest sticking point in the Irish negotiations. Germany’s fear of being the perpetual deep pocket for Europe and Irish intransigence on taxation are making this present crisis much more difficult to negotiate–much more so than just debits and credits.

A quick hitter: In tomorrow’s Financial Times, there is an article by EX-FED Vice Chairman Don Kohn and a former FED economist, Karen Dynan. The article’s headline, “Fed keeps its focus amid the criticism” is a defense of the FED and is actually picking up from the Bernanke Jackson Hole Speech. Kohn and Dynan argue that with such a large negative output gap there is no inflationary pressures and the FED is right in pursuing QE as the best alternative.

Failure to spark growth in the developed nations can lead to protectionism and other actions to halt global growth. The article pays homage to Bernanke’s view of the “Portfolio Balance Channel” that was detailed in the Jackson Hole speech. Quantitative easing results in lower bond rates, which forces investors to seek alternative assets as they rebalance portfolios. It pushes down corporate bond rates, raises equity values and even results in the outflow of DOLLARS from the U.S. in search other investments, which causes the DOLLAR to decline. Kohn and Dynan believe that these are very useful tools in an effort to generate growth in the U.S. The FED‘s action, they believe, will have a great impact on the start of a major restructuring of the global imbalances. There you have it: If you don’t want to fight the FED, then rebalance your portfolio and buy equities, sell bonds and DOLLARS. And, oh yes, HOPE THAT PIIGS CAN FLY OR CLICK YOUR HEELS TOGETHER AND SAY, “THERE’S NO PLACE LIKE HOME.”

Tags: Angela Merkel, Bond, Debt, Dollar, Don Kohn, Equities, EU, Euro, Fed, Germany, Ireland, Karen Dynan, QE

This entry was posted on November 17, 2010 at 9:56 pm and is filed under Europe, Federal Reserve. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.