Monthly Archives: December 2005

Mario Monti Makes A Reasonable Point

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Mario Monti – former European commissioner for the EU internal market – is interviewed in the FT today. On the recent ECB decision to raise interest rates he has this to say:

“Critics of the ECB say its monetary policy has been too restrictive. Mr Monti disagrees but says “there is an institutional credibility to be gained in the infancy of an institution. For a central bank, that is gained if you err on the restrictive, rather than the permissive side.”

Yesterday’s rate increase “is likely to avoid a weakening of that perception of credibility, and is likely to reduce the need for further increases in the very short term”, he said.”

I don’t entirely agree with him, but this is a reasonable explanation. I agree that you couldn’t exactly call recent ECB policy too restrictive. You really can only sustain that position if you think that what Germany really needs is a sustained dose of Japanese-style ZIRP (but to do this you would have to undo monetary union in my opinion, EMU wasn’t constructed with this type of problem in mind). We may get to this situation, but we aren’t their yet. Hence there is a plan b available, which is try to continue offering a bit of something for everyone.

In this context M. Monti is concerned about bank credibility, but he also makes a more subtle point: that a quick rise now buys time, and takes off the pressure for subsequent rises in the short term. As I say, I don’t entirely buy this, but at least it is a coherent argument.

What did Schily know, and when did he know it?

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This much is uncontroversial: in late 2003 the CIA kidnapped Khalid al-Masri, a Lebanese-born German citizen, and carried him off to a prison in Afghanistan for interrogation. In the end they released him when they realised that his only crime was to have the same name as some other man they wanted to get their hands on. It took them five months to realise this, five months during which al-Masri says he was tortured. He must be lying about that part, though, because George Bush has said that his administration does not torture.

Now, however, it looks like an extra-large family-size jar of controversy is about to be opened. Otto Schily, who was at the time Germany’s Innenminister — in this context, an analogue to the British home secretary or American director of homeland security — knew about the matter in May 2004 because then-US ambassador Daniel Coats told him. That’s not the controversial part. This is: according to a report in this week’s Spiegel, Schily kept quiet about the Americans kidnapping and falsely imprisoning a German citizen because Coats, his good friend, asked him to.
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Avian Flu In Ukraine

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We have what appears to be the biggest outbreak yet of the avian flu in Europe in Ukraine. More than 2,000 domestic birds have died of it in a remote region of the Crimean peninsula:

President Viktor Yushchenko declared a state of emergency in five villages on Saturday after the agriculture ministry said it had identified the H5 subtype of bird flu virus. Officials enforced a quarantine and began culling and burning the villages’ birds on Sunday.

But the government’s failure to notice the outbreak earlier is likely to heighten concerns across Europe about Ukraine’s ability to deal with the bird flu problem. Ukrainian villagers who keep birds in their gardens are at particular risk, because they regularly handle birds that may have come into contact with the migratory wild birds that spread the virus.

Very Difficult Negotiations Lie Ahead

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This was Tony Blairs view, that ‘very difficult negotiations lie ahead’ on the EU budget. You bet they do. Just look at the list of proposals:

– a cut in the seven-year EU budget to roughly €850bn, or 1.03 per cent of the union’s GDP;
– Britain would give up part of its rebate: €6bn-€9bn is the working figure used by officials;
– cuts of “no more than 10 per cent” to the €160bn of EU aid earmarked for new members in eastern Europe;
– cuts of about €5bn to rural development aid;
– a review of all EU spending in 2009, including farm support.

It’s The Yield Curve Stupid!

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Steve Johnson has been hard at it, writing away in the Financial Times:

“The chief problem for the yen is that the flattening of the US yield curve has made it uneconomical for Japanese investors to hedge their ongoing purchases of US Treasuries, but a falling yen encourages overseas investors to hedge their purchases of Japanese equities – negating the value of these latter flows in currency terms.”

More A Whimper Than A Cry

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Well the G7 meeting has come and gone, but I’m not sure how much the world is going to notice the fact. If I had been a fly, perhaps I would now be glad I hadn’t wasted my efforts. Basically there is a ‘shift’ from focusing on the oil issue to the inflation one, but given that in the two countries which are now driving global growth – the US and China – inflation is coming slowly but surely under control, I would have thought that this was to start to fall behind the curve instead of getting out in front of it. Put another way, since I am sure the Fed will push on through with the measured pace till the last drop of inflation oil is squeezed out of the US economy, I sure as hell don’t imagine that inflation is going to be tomorrow’s issue, and I guess this is the bit that the markets are really interested in.

“Finance ministers and central bank governors from the world’s leading economies have warned of increasing inflationary pressures, adding to concerns over rising protectionist sentiment and global trade imbalances….The warning on inflation came as the US Federal Reserve continues to tighten monetary policy and follows the European Central Bank’s quarter point rate increase last week – the first in five years. The Bank of Japan has also started to prepare the ground for an eventual curtailing of its exceptionally loose monetary policy.”

I think, btw, that the G7 are right to stress the importance of higher oil prices in the longer term as a constraint on the consumer, but this is ultimately a terms of trade effect – final consumption in the OECD world is squeezed as petro dollars mount up elsewhere – rather than an inflationary one as long as the monetary authorities keep the lid on ‘second round effects’. If you wanted to be really cynical you could say that the US government deficit was working as a giant paddle to keep the flow of funds moving, converting all those accumulated petro dollars into final consumption, but somehow I doubt Brad Setser would want to see things like this.

Robin Hood Or The Sheriff of Nottingham?

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José Barroso, European Commission president, yesterday advised Tony Blair not to act like the Sheriff of Nottingham, taking from the poor to give to the rich. I don’t know whether Tony’s been taking his advice, but this decision seems significant, and seems to reflect a willingness to try and get a deal. I don’t know what will eventually happen to the badly needed reform of the CAP though.

UK prime minister Tony Blair has signalled London will agree to cut its rebate from the EU budget, without a link to common agricultural policy (CAP) reform but through excluding new member states from contributions to the “British cheque.”…

London had, until now, insisted that a complex reform of EU spending, mainly on farm subsidies, is needed if the UK is to give up the rebate, which was negotiated in 1984 by Margaret Thatcher.

However, with France unlikely to agree on any farm cuts at the December summit, UK officials have revealed they will offer to freeze the UK’s €5.6 billion annual rebate at something close to the current level.

The solution is similar to one which London rejected in June, but the proposed British rebate cuts are less severe.

The Loophole

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The FT has just put this up:

The Kurdish regional government’s surprise announcement that it had begun drilling for oil in the north of Iraq sparked alarm yesterday, two weeks ahead of national elections.

As the FT indicates, the decision of the Kurdish government hinges on the controversial article 109 of Iraq’s constitution, which gives the federal government the right to manage oil and gas from “current” fields in co-operation with the regions and distribute it to the governorates according to population, but the article does not spell out the division of responsibilities for exploration and production in new fields. The following is also not without significance:

In August 2004, then-oil minister Thamer Ghadhban said Iraq had “unconfirmed or potential” reserves of 214bn barrels. Of this, the KDC estimates the Kurdistan region contains some 45bn barrels.

More Pressure on the Yield Curve

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One of the things about targeting expectations, and factoring-in changes, is that the world moves on at a very rapid clip these days. So the ECB rate rise in now, really, yesterday’s news. The big issue today is the fact that the easing cycle in the eurozone may already be over (we need to see the data going forward before we can be sure about anything here). Anyway, one thing the markets are sure about is that eurozone interest rates aren’t going anywhere very significant in the near future, and one of the consequences of this is the fact that 10 year German bund yields are on their way down again, as is the euro. (On this I continue to maintain my long held view that the situation is asymmetric: good news from the US, and bad news from the eurozone will send the dollar up, while the opposite will simply see exchange rates marking time. All of this has a floor, of course, somewhere, but I think we are still some distance from touching it). Of course all of this implies that the dangers of yield curve inversion in the US are now real and ever-present.

European bonds may gain for a second week, their first back-to-back set of increases in more than three months, on speculation any interest-rate increases from the European Central Bank will be limited.

The ECB raised its benchmark rate to 2.25 percent yesterday, the first time it has lifted borrowing costs in five years. ECB President Jean-Claude Trichet said the increase left rates in line with the bank’s goal of containing inflation, sending bond yields to a one-month low.

“There will be no additional rate hike immediately after this one, and the cycle will end at a relatively low level,” said Kornelius Purps, a fixed-income strategist at HVB Group in Munich. “That should be supportive for the bond market.” Economists at HVB forecast one more rate increase of a quarter percentage point next year.

The dollar rose for a second day against the euro on speculation a government report will show the U.S. economy added the most jobs in four months in November.

The U.S. currency also headed for a third week of gains versus the yen on speculation faster growth in the world’s largest economy will prompt the Federal Reserve to raise interest rates faster central banks than in Japan and Europe.

“There are no signs that the economy is slowing down,” said Niels Christensen, a currency strategist at Societe Generale SA in Paris. “Rate expectations in Europe and Japan are no match for the Fed, and so the dollar will keep rising.”

Locking Swords

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I’d simply love to be a fly on the wall in London this weekend. The G7 finance ministers are about to meet the central bankers, and as in by now well known, these two groups haven’t exactly been hitting it off too well lately, at least, and better said, in Germany and Japan they haven’t.

In particular I would like to hear John Snow’s contributions. Snow notoriously is banking on growth in Europe and Japan to ease the US out of its trade imbalance. But being pro-growth in the present context would seem to imply a stance on interest rates. The central bankers are worried about global liquidity and the danger of US yield curve inversion ( and here, for a very interesting discussion of the topic – certainly the best I’ve seen – from the Morgan Stanley GEF team). So one group want to put rates on hold, while the other wants to raise them, Snow is in the middle, but will he come off the fence?

Brad Setser has a post which has some relation to this.

Brad seems to take the view that a big part of the explanation on global imbalances is the US fiscal deficit. I beg to differ. Indeed I think Brad is in danger of putting himself on the wrong side of an old (1930s) argument that probably he wouldn’t want to be on the wrong side of.

Let me explain: the important thing to watch is the global economy (not the local examples, US, Germany, Uk, China etc – Hat-tip to Andy Xie hear although I don’t have the direct link handy). Now what is important is the global equilibrium, in terms of the sustainable global growth rate. Now……. simply applying a restrictive fiscal policy and a tighter monetary one in the US would bring the budget into balance and the external trade deficit down, but what would happen to the level of employment (in the US and globally)? What would be the knock-on consequence for growth in China? Would this be a ‘better’ equilibrium than we have now, would it be more sustainable? Somehow I doubt it. And I think that is why we need to address this issue globally.

Which takes me back to being a fly on the wall in London……