Notes From Underground

The German Constitutional Court is scheduled to hear the arguments in the issue of the constitutionality of the ECB providing unconditional funding for the bailouts of European sovereigns plagued with financial problems. The main issue really becomes this: Can the ECB consign German citizens to be the paymasters for the entire European project without their DIRECT CONSENT–or what the highly regarded Otmar Issing rightly called “taxation without representation” in an FT op-ed piece several months ago? Germany’s Constitutional Court sits in Karlsruhe and decides major issues of law impinging on the legality of the BASIC LAW. Previously, the court has held that the sovereignty of the people resides in the Bundestag but has warned that the transfer of German wealth and property to an outside foreign body has its limits without direct consent of the people. Where does the demands of the European Union conflict with the sovereignty of the citizens in determination of German rights?

Mario Draghi has pushed the potential limits of this issue by “stating the ECB will do whatever it takes” to hold the euro zone together as he announced the Outright Monetary Transaction (OMT) as a way to calm the fragmentation of the EU credit markets in July 2012. Jens Weidmann, president of the German Bundesbank and ECB executive board member, vehemently protested that it was not the duty of the ECB to rescue states in trouble. President Weidmann, as well as many other high-profile Germans, will be speaking to the Karlsruhe Court opposing the actions of the ECB. The ECB itself will be represented in its argument for the OMT and other types of QE by Jorg Asmussen, also a German and member of the ECB executive board. Mario Draghi rightly opted out so as to make this a German discussion and had the cover of claiming that the economist Asmussen was much more informed about German law. The ECB will argue that OMT is within the bank’s mandate for this reason: THE ECB HAS A SINGLE MANDATE OF PRICE STABILITY AND THE NEED FOR OMT AND OTHER QE PROGRAMS IS TO PREVENT THE ONSET OF A DEFLATIONARY PRICE SPIRAL FROM TAKING HOLD IN EUROPE.

The popular belief is that price stability in the public mind has in recent times meant inflation, but the argument from Draghi will be that the DEFLATIONARY SPIRAL can be more economically corrosive then inflation and thus the ECB mandate means that the central bank has to maintain PRICE STABILITY. Though the Karlsruhe Court will not render its decision until probably after the German elections in September, this matter is of no small importance. The discussion before the court will help draw the battle lines in the upcoming election and will weigh on German sentiment about Europe. Remember that as of this moment, no money has been drawn upon the OMT program, but if the German Court decides in favor of the Constitutionality of the ECB‘s financing programs, President Draghi will be able to open the floodgates of liquidity. The EURO currency has held up well because of what Draghi admitted to in his press conference of last Thursday: “The ECB has been the most conservative of all the central banks.” If the German Court removes the threat of Bundesbank action on the issue of quantitative ease the ECB will truly enter the “global currency wars.”

***Two quick points from Japan: Tonight, the Bank of Japan (BOJ) will announce its decision on interest rates. While I expect no change to the present policy and quantitative ease program, the announcement may offer some clarification of BOJ asset purchases, such as which bonds the BOJ will be buying and of what duration, though there can still be a great deal of volatility. Also, we need to be prepared to hear if the BOJ will be buying equity assets, as well as bonds, although the massive buying of BONDS has the effect of aiding the NIKKEI as Japanese domestic investors are playing out a Bernanke type “PORTFOLIO BALANCE CHANNEL.” If pension funds and insurance companies are taking losses on their bond holdings they will be compensated with large gains in their equity investments. It is for this reason that I believe we are going to see a dramatic change in corporate governance in Japan and  highly profitable corporations are going to be “forced” to distribute more cash in the form of dividends and unlocking shareholder value. This is why I think that active investors such as Daniel Loeb are being activist at the right moment. The ABENOMICS TEAM will be supportive.

Second, French President Hollande was in Japan over the weekend and in a speech he delivered he noted: “What you need to understand here in Japan is that the crisis in Europe is over.” My question is: ARE YOU NUTS,PRESIDENT HOLLANDE? The Japanese have targeted the EURO/YEN currency cross and provided the backdrop for a 35% depreciation of the YEN against the EURO, targeting the German export market. If you tell the Japanese that euro is now healing, there will be no pressure on the Japanese to alter the massive QE program, which has helped generate a massive outflow of capital from Japan. The recent Japanese economic data has shown some improvement  and much of it coming from the new improved competitiveness of the export sector. As the ECB just said, Europe has experienced six straight quarters of negative growth and its most powerful economic engine, Germany, is under assault from the Japanese export machine. The crisis in Europe over? It may be just getting started, Mr. Hollande.

Tags: BOJ, ECB, Euro, Europe, German Constitutional Court, Hollande, Jens Weidmann, Jorg Asmussen, Mario Draghi, OMT, QE, Yen

This entry was posted on June 10, 2013 at 6:52 pm and is filed under BoJ, Currency, ECB, Europe, Japan. 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.