Yesterday, it was the issue of imbalances and the need for currency manipulation as seen through the eyes of a hegemon in decline. Today there was more criticism of German intransigence as Mario Draghi was pushing back against criticisms from Wolfgang Schaeuble that ECB policy was igniting the fire of the radical right. President Draghi said the ECB was correct in its policies, and current and trade surplus nations were at fault for the continued economic malaise for not embarking on large fiscal stimulus programs. Mario Draghi is lashing out against the German passion for fiscal austerity and labor restructuring, but the ECB President seems to forget the golden rule: He who has the gold makes the rules. I ASK MY READERS TO PONDER THE QUESTION (AGAIN): Who guarantees the balance sheet of the European Central Bank?
Logic says that a central bank has the power of the printing press and therefore needs no financial backer. The model of the Federal Reserve is irrelevant for the ECB because the European Union has no HARMONIZED FISCAL POLICY. Without a central taxing agency there is not ultimate financial support. In the United States, the municipal bond market stands on the strength of the power of each sovereign entity to tax and therefore meet its financial obligations. In Europe, each sovereign tax certainly has the power to tax, but as we have seen in Greece the power to tax is not necessarily the key to low interest rates and economic growth. As the ECB purchases 80 billion euros of assets each month the central bank’s balance sheet grows well beyond the EU’s centralized taxing abilities. President Draghi can criticize German fiscal policy but it is ultimately the German’s good credit that the presumes will guarantee the ECB. BUT IF MR. DRAGHI CONTINUES TO PUSH AT HIS FINANCIAL SUPPORTERS HE MAY TEST THE GERMAN WILL TO BE THE ULTIMATE TRANSFER AGENT.
Greek 10-year notes are yielding 8.62%, while Greek two-year notes are yielding well above 10.0%, even as the ECB purchases various sovereign assets. The global financial system is in an extremely fragile state and attacking the financial stalwarts is not an appropriate policy for a time of great uncertainty. It is the beginning of the month and the initial response of the European bond markets has been to sell the peripheral debt (i.e.Spain, Italy, Portugal) while buying French and German paper. The ECB is loaded with buying power so watch for days when the ECB is in buying the peripheral debt, compressing the spreads and then seeing where the markets push the yield differentials back to after the ECB pulls out.
Draghi maintains that the low interest rates are due to an imbalance of savings versus investment (the Bernanke thesis), but with China initiating massive amounts of debt those balances OUGHT to be receding, pushing interest rates higher. It appears that Central Bank intervention will prevent that from happening—-IMBALANCES are in the eye of the HOLDER.
***Last night the Reserve Bank of Australia (RBA) cut its interest rate 25 basis points and because it was somewhat unexpected, the Aussie dollar declined more than 2%. It appears that Governor Stevens didn’t receive the memo from U.S. Secretary Jack Lew about currency manipulation for the RBA statement was far too upbeat to sanction a rate cut. In previous RBA statements, the Bank’s Governing Board had alluded to the value of the Aussie dollar as a prime criterion for monetary policy choices. This statement had only this little bit: “Monetary policy has been accommodative for quite some time. Low interest rates have been supporting demand and the LOWER EXCHANGE RATE OVERALL HAS HELPED THE TRADED SECTOR,” (emphasis mine).
It was a brief nod to the impact of the Aussie dollar and overall not a negative sentiment for the economy. Governor Stevens’ did, as usual, mention China but it was also in a sanguine nature: “China’s growth rate moderated further in the first part of the year, though recent action by Chinese policymakers are supporting the near term outlook.” It seems that the Aussie economy has not been slowing enough to warrant a CUT but the RBA wanted to cut to affect the CURRENCY and buy some insurance against a possible Chinese slowdown. Waiting to hear from Secretary Lew to see if the Aussies violated the spirit of the G-20 Shanghai Accord or if Australia falls afoul of the Trade Facilitation and Trade Enforcement Act. Hey, Secretary Lew, “shots fired, currency down.”