What's in Store for European Economies?

Well, Macro Man highlighted the issue of trade yesterday, but even he was surprised by the US trade number for November. The $40.4 billion deficit was much better than expected, and indeed the narrowest in nearly 5 years. While Macro Man had been troubled by the October report and its implication for his constructive dollar view, yesterday's data boosted his confidence in his economic analysis. (Though as observed yesterday, that does not necessarily translate into market success!)

What was particularly striking about yesterday's figures was the sharp decline in both imports and exports, providing further support for yesterday's theme. Macro Man received some pushback on his claim that the Baltic index represents true supply and demand for shipping (though why the unavailability of trade finance somehow doesn't count as a determinant of shipping demand eludes him), so he was curious to see an article in today's Torygraph suggesting that container rates on same routes have hit zero due to - you guessed it - falling demand.

Another source of curiosity yesterday came from a Market News story about tomorrow's ECB meeting. It must have been a slow day chez MNI, as they evidently had the luxury of time to ring around a few different ECB moles. The divisions within the ECB were pretty much laid out for all to see; one guy pretty much said "we're buggered", 50 bps is a done deal, and we'll push for more. Another was quoted as saying that the bottom may already be in and that they have to worry about eventual inflation.

Now Macro Man has had a go at the ECB before, and frankly been surprised at the amount of reader support for JCT and co. But frankly, he's left wondering if we will need to create a new species for the ECB; traditionally, central bankers are divided into "hawks" and "doves". Perhaps we'll need to include "frogs" on the ECB...as in Kermit...as in Muppets. Where was this concern about the forward outlook in August, as oil was already on the way down? As things now stand, the ECB looks set to miss its inflation target on the downside by as much as it blew it on the topside. Good work, lads!

At the same time, there are more insidious structural headlines beginning to hit the tape. S&P, for all their many faults, have been conducting one of their periodic reviews of sovereign credit ratings over the past few days. Nations like the US and UK have had their ratings affirmed, while the PIGS are on negative watch (Ireland doesn't show in the chart below for some reason).

Now, Macro Man isn't a Bernard Connolly type character who hates Europe for the sake of it. But he cannot help but wonder if the last year or so hasn't put a dent in the attraction of the euro as a store of value. After all, many FX reserve holders in Asia and the Middle East have belatedly come to realize that holding euros isn't any good if you need dollars to defend your currency. That in and of itself would argue for a higher dollar weight than a purely Markowitz approach would dictate.

Moreover, insofar as the current crisis has been all about the small print, the Eurozone has small print in abundance. Less than half of the countries in the Eurozone enjoy a AAA rating (though obviously a bigger percentage of Euroland GDP is AAA), and recent market developments have confirmed that EMU assets, including government bonds, are not, in fact, perfectly fungible. BTPs are not a government trade these days, they are a credit trade.

And while Ireland may not call in the IMF, a worst-case outcome for the economy and the banking system could raise serious questions about some countries' ability to pay their liabilities. Not exactly what you want to see in a reserve currency!

And try as he might, Macro Man cannot find the mechanism or gameplan within Europe should, say, Greece decide to withdraw from the single currency because it cannot afford its euro liabilities. The standard European response seems to be "we don't need a plan because that cannot happen."

Funnily enough, that sounds an awful lot like S&P's comments on their subprime housing model should house prices decline in the recent Michael Lewis article (page 5, to be precise). And didn't that end well...

Comments

[boisterousbob:]

Macroman you continue to delight!

I found this comment in the referenced torygraph article particularly telling:

'It became difficult for the shippers to obtain routine letters of credit at the height of financial crisis over the autumn, causing goods to pile up at ports even though there was a willing buyer at the other end.'

I wonder if the nightly television pundits pumping shipping stocks as the BDI "has now bottomed" would concur!

Jan 14 06:11 PM

[Ferdinand E...:]

A piece of advice macroman: better switch your attention to the rim of the Sahara or garden spots like Guadacanal, because your knowledge of European macroeconomics/finance is not quite up to snuff.

Jan 15 08:51 AM

[OldLimey:]

Macro Man: Like many others, I very much enjoy your posts - but on this one, the question is where to begin.

1. "Now Macro Man has had a go at the ECB before, and frankly been surprised at the amount of reader support for JCT and co." The reason for reader support is that JCT represents the nearest thing the world has to a proper central banker, by which I mean a central banker who isn't wedded to the sustaining of asset price bubbles and mispriced risk. Sure, he has got it wrong from time to time. But I hope there are a few arrows left in your quiver for other central banks, and one privately owned central bank in particular, that have got it wrong on a serial basis for over two decades.

2. "S&P, for all their many faults...." Aren't we being a tad glib with issues such as competence and integrity here?

3. "Now, Macro Man isn't a Bernard Connolly type character who hates Europe for the sake of it." Honest?? Whilst I'm absolutely certain that your primary motivation by far is your P/L, you don't seem to pass up many opportunities to have a go at Europe in general and the EUR in particular. I admit I have a tendency to see shadows on grassy knolls and in Paris tunnels, but it is at the very least curious to me that in recent months when the USD's status as the world's only serious reserve currency has become central to the survival of the US economy as currently structured, the number of American EUR-bashers has multiplied significantly. (That one should be worth a few extra thumbs-down, so in for a penny.....)

4. "But he cannot help but wonder if the last year or so hasn't put a dent in the attraction of the euro as a store of value." Remind me: how well has the USD stored value since, let's say, Nixon dumped gold?

5. "After all, many FX reserve holders in Asia and the Middle East have belatedly come to realize that holding euros isn't any good if you need dollars to defend your currency." Holding EURs and holding USDs are not mutually exclusive reserve choices, as you well know. What the people I talk to in Asia and the Middle East want is greater diversification, not the replacement of the USD. A mass exodus from the USD is pretty far-fetched, but a gradual move of future foreign currency earnings into alternatives is surely inevitable given what foreign holders of USDs can see going on in Washington and on Wall Street.

6. "Nations like the US and UK have had their ratings affirmed...." The only reason the US deserves a triple-A rating without even the hint of a downgrade is that it prints the world's major reserve currency. So here we have the relationship that, as noted in point 3., has to be defended at all costs: any threat to the USD's pre-eminence is a threat to the triple-A rating which is a threat to the country's monetary and fiscal edifices. As for the UK warranting an unquestioned triple-A rating, you live here so surely I don't have to waste time describing how shot-to-pieces the economy is; if it were any other country we'd be holding hands with Spain in the long march down the pecking order.

7. "Less than half of the countries in the Eurozone enjoy a AAA rating (though obviously a bigger percentage of Euroland GDP is AAA), and recent market developments have confirmed that EMU assets, including government bonds, are not, in fact, perfectly fungible." What on earth makes you think that all EUR sovereign assets either should be or need to be triple-A and fungible? The 'M' in EMU stands for 'monetary'; there's no 'F' for fiscal' or 'E' for economic. Sovereign credit spreads in the eurozone have been too narrow for too long, and as in so many spheres of finance some recognition of reality has begun to dawn on people who have spent the better part of a decade mispricing risk.

8. "And while Ireland may not call in the IMF, a worst-case outcome for the economy and the banking system could raise serious questions about some countries' ability to pay their liabilities. Not exactly what you want to see in a reserve currency!" Any comments on the fact that the money centre banking system in the US is insolvent and the big three are likely candidates for nationalisation.? Doesn't that say as much about the US as Ireland's troubles do about the eurozone?

9. "And try as he might, Macro Man cannot find the mechanism or gameplan within Europe should, say, Greece decide to withdraw from the single currency because it cannot afford its euro liabilities." Why on earth would Greece or Ireland or Spain want to leave the eurozone? Liabilities in New Drachmas, New Punts, or New Pesetas wouldn't exactly be cheap to fund, would they, and there would be pretty impressive premia on their foreign debt. These countries are far better off inside the eurozone than outside, which is why the likes of Slovakia have been so keen to clamber abroad. The only contender for the exit (and not a very serious one at that) is Italy, largely because Benito Berlusconi and his crew can see attractions in devaluing their export-dependent economy back into prosperity. Yeah, like that worked before. But say I'm wrong and Club McMed departs: wouldn't an EUR based around just Germany, Benelux, and (swallow hard) France look an even better bet as a reserve currency? (Provided, of course, they don't let us Brits in as well.)

Notwithstanding all that, thanks for your musings on the markets - keep up the good work (and stop reading the Telegraph, it destroys brain-cells as surely as too much alcohol).

Jan 15 02:26 PM