Carlo's Think Pieces

Reflections of a Filipino in the Netherlands

Posts Tagged ‘Credit Default Swaps’

Americans Inflating Euro Crisis

Posted by butalidnl on 20 September 2011

Americans are aggravating the Euro crisis for their own ends. While there is indeed a problem with the Greek economy, America has made sure that it has developed into a full-fledged Euro crisis.

Euro Crisis?
If the news stories are to be believed, it seems as if the Euro is about to fall apart, and countries will have to revert to their own currencies. This is a myth. In the first place, Greece (and Ireland & Portugal) are small fish compared to the Euro area as a whole, and their problems could not bring the whole currency down. But the main reason why the Euro won’t fail is the strength of the German-France commitment to the Euro. This is something that no American can really understand.

Germany and France see the Euro as the embodiment of their European project, and this means they are committed to it fully. Germany felt the same way about German reunification, and it poured trillions of Euros (then DMs) to make East Germany catch up with West Germany. People were willing to even pay an extra tax just to finance this. The European project is seen by Germans as the thing that ensures the peace and stability of Europe, literally. If the Euro falls, the EU will break up, and a depression and even civil wars may ensue. Germany and France had fought 3 wars with each other, in rapid succession, before the European Community was formed. No sacrifice is too big to prevent this from happening yet another time. There is absolutely no way that the Germans and French will allow the Euro to fail.

Ignorance
America has been doing its best to inflate the Euro crisis. This is due to ignorance, self-interest, and in some cases even malice. Americans are ignorant in that they don’t understand how the EU works. The EU works slowly; but is capable of making huge changes if necessary. EU decision making is a very public affair, with many negotiating positions discussed in the various parliaments and the media. In the end, though, Europe is very pragmatic, and it is actually easier to decide among the 17 members of the Euro-zone, or the 27 EU countries, than it is in the US with its two feuding parties.

In  a sense, the Germans are using the ‘crisis’ for their own ends. The crisis is convenient to force the Greeks to give concessions. But this is part of the public way in which the EU decides on policies. The Germans, and everybody else in the EU, have been using tactics like this since the beginning.

Many Americans, who depend on their 401k funds for their pensions, do not understand the EU dynamics. And they are driven to panic by US  ‘analysts’ and even political leaders who have done their best to inflate the problems with the Euro.

Self Interest
The US government is consciously undermining the Euro in order to stabilize the US Dollar. Because, in the face of the dollar’s instability, to have a stable Euro that could function as a safe haven and even alternative reserve currency would cause a flight away from the dollar. Thus, US government officials are constantly reminding the public (mainly the panicky holders of 401k accounts) that the Euro is in crisis. Obama would say something like: “European countries are as able to repay their debts as America is” – which on face value may pass as some kind of support for the Euro, but which is calculated to remind Americans that investing in the Euro is risky.

Geithner’s supposedly unfortunate comments during the recent EuroFin meeting in Poland (16 & 17 September) is passed as a gaff, but it was perfectly consistent with their policy of overly emphasizing the Euro’s problems. The Euro crisis is just what Washington ordered – as far as they’re concerned, the Eurozone’s crisis should extend at least till after Obama is reelected.

Malice?
There are also those in America who are actively sabotaging the Euro for financial gain. Hedge-fund managers buy CDSs (Credit Default Swaps, financial instruments that ‘insures’ against sovereign default) on bonds from countries such as Spain, Italy or France or sell their bank stocks short. Then they spread rumors that that country’s banks are overexposed to Greek debt.  As a result, the price of the CDS skyrockets and bank stocks fall, and the hedge funds cash in.

Hedge funds have been rightly blamed by European governments for undermining the Euro. Some EU governments have prohibited short selling of bank stocks. The EU and specific countries are investigating the speculation in CDSs. But hedge funds are nimble, and are very difficult to pin down. Hedge funds love doing their dirty techniques against the Euro because they can get away with it. The American public is nervous enough that even small rumors are picked up and could have big effects. Another reason is that hedge funds fear EU investigators much less than US monetary authorities. If they attacked the dollar similarly, they would face far harsher punishment than if the EU catches them.

What Now?
There is now a real Euro crisis, thanks to the Americans. This crisis has depressed the value of the Euro and stock prices. Even though the Euro will not fall, EU governments now have to scramble to control the immediate problems.

While the France-German commitment to the Euro is absolute, this does not mean that they will bankroll Greece forever. They just might opt to have an ‘orderly default’ of Greece, or even kick Greece out of the Euro-zone. After all, Greece didn’t properly qualify to enter the Euro-zone; it had doctored its economic figures to qualify.

But Americans are now being bitten back for their anti-Euro efforts.  Their stock markets (and thus the pensions of millions of Americans) have declined dramatically. International investors and even Central Banks are buying gold at an alarming rate, pushing the gold price ever higher. And the relatively cheap Euro means that the US trade deficit with Europe will only continue to grow. American trashing of the Euro is proving to be only a temporary solution to the US Dollar’s problems. It has led to the US losing precious time that it could have used to decisively address its own problems.

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$1.45: 1 Euro by the end of 2011

Posted by butalidnl on 31 December 2010

The year 2011 will be marked by a very significant deterioration in the dollar exchange rate. I think that the exchange rate by this time next year will indeed be $1.45: 1 . Why do I think so?

Why?
Well, the most obvious reason is that the US is printing too much money, accumulating too high budget and trade deficits, and borrowing too much. The US Fed is stimulating the US economy as if it was the only economy in the world. They don’t see the international effects of US economic policies. Well, I think that 2011 will show that there is a limit to the amount of US dollars the world can take. At a certain point, people from other countries will have to be convinced by high interest rates to invest in US treasuries. And this would mean a devaluation of the dollar.

Even without “Quantitative Easing 2” and the extension of the Bush tax breaks, I think the US dollar will be in trouble anyway. At the beginning of the year, Central Bankers (Central Bankers are very “neat” in that they make policies that start at the beginning of the year, or half year, or quarter) will most likely set their policy regarding the amount of US dollars they will keep in reserve for the coming year. And I think that they will set the target percentage for dollars at either the same or at a lower level than that for 2010.  The dollar is a declining component in world trade, and it is also expected to devalue, so prudent Central Bankers will aim to have a lower percentage of dollars in their reserves. This, together with the rise in the amount of dollars that go around the world’s financial system, would mean that there will be a growing amount of dollars that are dumped by all these Central Banks. All these extra dollars means that the US dollar will devalue.

What about the Euro and its crisis? Well, to make the long story short: the Euro crisis is over. 2011 will be the time of the dollar crisis; and as a result, the problems of the Euro will be overlooked or actually get solved. Investors are sure to notice that the US economy is heavily indebted, and that the dollar is devaluating; so, they will think twice before buying US treasuries. After all, the US economy is worse off that either the Portuguese or Spanish economies. People will see that, and will eventually have to act accordingly.
This will bring about a domino effect: lower demand for treasuries; speculators betting (through Credit Default Swaps e.g.)that the interest on treasuries will rise; interest on treasuries actually rising as a result, etc. If speculators get the idea of dumping their other US dollar denominated assets, then devaluation will surely result.

The US can still stop this trend of a devaluating dollar. However, I think it won’t, and for the simple reason that they want the dollar to devalue. US economists seem to think that this is a good idea – that devaluation will stimulate exports and lessen imports. So, the Fed will not do anything to defend the dollar; and thus the dollar will devalue in 2011.

Is Devaluation a Good Idea?
For a small economy, it indeed could be a good idea to devalue its currency in order to restore its balance of trade. Devaluation will make that country’s exports cheaper and make imports more expensive, forcing the market to restore the trade balance after a while.

For the US dollar, however, it will be a bad thing if it devaluates. And this is because it is the world’s main reserve currency. Devaluation will not only lower the price of the US’ exports, it will also lower the value of reserves other countries have built up. For many countries, holding US dollars becomes a game of chicken: they would keep it as long as possible, but dump it before everybody else does. But when the Central Banks start dumping dollars, there will be no stopping the trend.

So, devaluation will not only affect the trade balance. It will affect how other countries view the dollar. And this means that if they sense a trend of devaluation, they will  dump their dollars in the hope of preserving the value of their reserves.

Devaluation will also be bad for the US itself. When the dollar loses value, the amount of imports will take 6 months or longer before it starts going down. This means that oil and other commodities will sap the US trade balance for some time before going down.  And it will take some time before exports get a boost. There is a lag time before companies are able to increase production accordingly.  And there is China: if present trends continue, China’s yuan will maintain its value rate relative to the dollar. This means that imports from China will not be affected, and exports to China will also not increase.

Devaluation will mean that people will pay a higher price for oil. I would estimate it to reach $4/gallon in 2011, at least. Other commodities will also rise in price: from iron ore to rubber, copper, aluminum. And this will cause the price of goods produced in the US to rise accordingly.
Devaluation means that consumer prices in the US will rise. It may not rise by the same percentage as the devaluation, due to importers absorbing part of the loses, but it will surely rise.

Devaluation of the US dollar, if it goes beyond a point, would mean that other countries would consider dropping the dollar as the currency used to price certain commodities. Take for instance oil – it is still denominated in dollars. But if the dollar devalues too much, OPEC may just decide to drop the dollar/barrel measurement, and revert to perhaps a Euro to metric ton pricing.

It could be worse
That the dollar will devaluate, is practically a given. But a depreciation of 10% is not the worst possible case. It could indeed be worse. Here are some things that could make the scenario even worse for the dollar.

Germany Agrees to ECB Issuing Euro Bonds. So far, the Germans are holding back on this, for the reason that it pays much lower interest rates with the present system of each country issuing its own bonds. However, if for whatever reason, the Germans (and other “Northern” countries, e.g. the Netherlands) agree to let the ECB issue common bonds for the whole of the Euro zone – which would then have an “average” interest rate; then it will forever get rid of any reason for a Euro crisis. And this would mean that international investors will more enthusiastically tear down the price of US treasuries.

China Shifts Its Peg to a “Basket of Currencies”. If China lets go of its dollar peg, it will not be good for the US. It’s funny – the US has been insisting for years that the Chinese should revalue its currency. But if China does so, even if only a little, it will mean a lot of trouble for the dollar. Changing the peg for the yuan will mean almost certainly that China will stop buying US treasuries. This means that the price of treasuries will drop, and effective interest rates on them will rise.  And China’s dumping of US treasuries will be sure to trigger similar actions by other countries.

Big Disruption in the Supply of Oil. The price of oil is now at about $90/barrel.  It will slowly rise to about $100/barrel by the end of the year, given present supplies.  If there were to be a major disruption in the supply of oil – perhaps a total stop of Nigerian or Venezuelan exports – the price will rise to even $150/barrel.  While the world has seen these price before, it is now less able to cope with it. So, a big rise in the price of oil will be greeted by a return to recession for the US, and a big drop in the value of the dollar.  The dollar will lose more than 10% of its value, as a result of this.

I don’t think that these “worse case” scenarios will happen in 2011 (well, 2012 is another story altogether). So, this means that the US dollar will devalue by “just” 10%.

Unfortunately, I think that this trend is inevitable. The dollar will devalue by about 10% in 2011. It may devalue by the same amount in 2012. And if this continues, the dollar will cease to be the main reserve currency soon after. Only the Fed can stop this. But it won’t. It is not politically expedient for the Fed to do so.

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Euro Crisis?

Posted by butalidnl on 31 May 2010

These days, if you watch CNN (and most other American or British media) you would get the impression that the Euro is about to collapse as a currency; and that European countries will have to reinstate their old currencies. It is truly amazing how the Americans especially have fooled themselves into believing that – and now, they are panicking at the possible effect a fallen Euro will have on their investments.

Well, I think this is quite ridiculous; but don’t take my word for it, look at the facts.

Greece Crisis is Over
In the first place, the crisis with Greece is over. The Greeks have implemented deep cuts in government expenditures, and the rest of the Euro zone (and the IMF) are granting them enough loans to be able to rollover their existing debts for the next three years. After 3 years, Greece will still have a deficit, but this will be more manageable; and there would be enough safety nets in Europe to be able to ensure that Greece could rollover their debts easily by that time.

Structural Problems with Euro are getting addressed
In the meantime, Euro zone countries have put up nearly a billion dollars worth of loans and loan guarantees in a special fund to be able to aid other Euro zone countries who might come into trouble with their deficits and debts. This is a fund which is more than the US’ TARP funds that were used to save the US banking system. I believe that this fund is big enough for any problems Euro zone countries could face.

And then, the European Central Bank (ECB) has been given authority to buy up bonds from individual countries. This means that the ECB will in effect be doing “quantitative easing”, or printing money to be able to rescue member countries, if this is deemed as necessary. Of course, I expect that the ECB will use this new authority rather sparingly. The US Fed and the Bank of England has been using “quantitative easing” quite a lot these last couple of years.

In addition, various southern Euro countries have cut back on their expenses, way before the markets have any chance to attack them, like they did with Greece. In recent days, Italy, Portugal and Spain have announced new budget cutbacks (including cutting the salaries of Cabinet officials) , showing the world that they are taking serious steps to reduce their budget deficits.
And there are continuing discussions among Euro finance officials to set up a mechanism to ensure that countries do not exceed the 3% limit for budget deficits.

Panicky Americans
So, with the concrete causes of the crisis avoided, why are Americans panicking about the Euro? Well, I will attribute it to two things; first, it is to the interest of those who speculated against Greece or Spain to somehow make a profit. Rumours may not cause the bankruptcy of Greece or Spain, but they will maintain the price of their put options or Credit Default Swaps (CDS); the price of these will not go down as long as some people think that there is a chance of default.

And second, is that Americans do not understand the mechanics of European decision making. When Angela Merkel of Germany talks about the possible fall of the Euro, this may be true, but only in the long term. For domestic consumption, though, she would be quite grave about it, so that parliamentarians will be forced to support the various rescue programs etc. However, this is the way Europeans come up with common policy. European politicians are known for their brinkmanship, and their hyperbole especially towards domestic audiences. Then, they sit down together in marathon sessions, and viola – they agree on a solution, at the last minute.

We in Europe are used to this kind of brinkmanship and hyperbole of our leaders. We may be concerned about the Euro, but we know that most of the problems are on the longer term, and that our officials are well on their way to solving them. So, we don’t worry too much about it.  But Americans are a panicky lot – they think that the Euro is about to fall apart, that Spain is about to default, and as a result they withdraw their portfolio investments from Europe. This consequently lets the exchange rate of the Euro fall, and then the Americans panic even further – thinking (correctly) that this will decrease European demand for American products.

Well, Europeans don’t worry about their Euro falling apart any time soon.  True, the devalued Euro may make imports more expensive and make travel outside Europe costlier; but exports are booming, and imported products are low-priced anyway as it is, and they just need to plan their vacations within Europe instead of to more distant destinations.

So, for as long as it lasts, Europeans are going to enjoy the low value of the Euro. Of course, this can’t stay this way forever, especially with the growing surplus trade with the dollar zone. But it will be nice, for as long as it lasts. Actually, if I were an American, I will be well advised to buy European stocks or bonds now, while the Euro is still low; I will be sure to make a big profit in a year or so, when the Euro will be back to more “normal” levels.

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