Markets Prepare For Next European Summit

Includes: FXB, FXE, FXY, UDN, UUP
by: Ralph Shell

Global equity markets traded higher today, hoping the next European Summit will provide some solutions to the current debt crisis. The U.S. equity markets, following the trend in Europe, are now trading over 1% higher. Early the currency markets favored the euro and pound at the expense of the U.S. dollar and the yen.

The summit is not until December 9th. Currently positive results are anticipated, as optimism often prevails in advance of these meetings. Various grand plans and sometimes trial balloons are unveiled. The problems, however, are a lot greater than the debt and currency crisis. Some of these issues are described in an article by Robert Samuelson. He says in part:

But Europe's turmoil is more than a currency crisis and was inevitable, in some form, even if the euro had never been created. It's ultimately a crisis of the welfare state, which has grown too large to be easily supported economically. People can't live with it - and can't live without it. The American predicament is little different.

Government expansion was one of the 20th century's great transformations. Wealthy nations adopted programs for education, healthcare, unemployment insurance, old-age assistance, public housing and income redistribution. "Public spending for these activities had been almost nonexistent at the beginning of the 20th century," writes economist Vito Tanzi in his book Government Versus Markets.

The numbers - to those who don't know them - are astonishing. In 1870, all government spending was 7.3% of national income in the United States, 9.4% in Britain, 10% in Germany and 12.6% in France. By 2007, the figures were 36.6% for the United States, 44.6% for Britain, 43.9% for Germany and 52.6% for France. Military costs once dominated budgets. Now, social spending does.

The expansion of the welfare state and the affiliated costs can be afforded when economies are growing at 4%, and when interest rates are low. In recent years, the only growth has been in the promises made by the politicians to the recipients of the welfare state. The 2008 financial crisis, with stunted growth. Now with interest rates rising, the cost of financing maturing sovereign debt, the cost of the welfare state increasing as the population ages, we have a multifaceted crises. It is naive to think there is some magic quick fix to the myriad of problems.

This is not to imply that the euro has a monopoly on these problems. The United States likewise has them, but they may not be quite so pressing.

In an article late last week, "If the Euro Were a Car, It would be Recalled," I did not wish to infer that the car was ready for the junk yard, but merely, there had to be some adjustments. Also, I did not mean to imply, as an American, I was biased in favor of the USD.

It seems to me some people view the value of their currency as a matter of nationalistic pride. Personally, I merely prefer to be long the one going up or short the one working lower, but at this time I am somewhat conflicted. Within a fortnight, as the Brits say, I will be relocating to the other side of the Atlantic for several years, buying a car, learning to drive on the wrong side of the road, and spending euros in the local economy. It will be a new adventure.

The EUR/USD seems to trade better than the news, all of which seems bearish. If it is really bearish, it should go down, but the euro stays in the 1.34s. This, in spite of the big build in the speculative open interest. This makes me wonder, who is buying the euro? In the latest COT Report, the specs increased their short position to 133,227 contracts.

The big spec short interest is worrisome, however. Most of the the positions are held by the very large traders. Normally these traders are better informed and better funded, inclined to stay with the trend. The trend is lower, but we worry some of the pre summit pronouncements may give us a rally. Often bold headlines are negated by the small print. Should we make it back to the 1.3550 level, we will try the short side, but failing that we intend to wait for new developments.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.