Category Archives: Economics: Currencies

In Lira, or in Euros?

Posted on by

Even if it is a debatable question whether or not the Iraq war is bogged down in a quagmire, Italy’s economy evidently is. And no-one has even gotten round to offering a plan ‘b’, not even Tony Blair himself. So the silence is deafening, and this simply leads to increased speculation. Berlusconi only pronounced publicy on the issue last Tuesday, nearly three weeks after Maroni’s referendum call. Latest on the list of those taking a long hard look is Bloomberg’s Mark Gilbert, who has dug out an old paper by legal expert on international financial systems Hal Scott.

The key points:

“Countries have kept their own payment systems, government debt instruments, central banks, and the lion’s share of their foreign-exchange reserves,” wrote Hal Scott, professor of international financial systems at Harvard Law School, in a 1998 paper. “It is almost as if the EMU countries have hedged their bets on EMU by retaining the key institutions needed to re- establish their own currency and monetary policies if need be.”

Scott’s paper, titled “When the Euro Falls Apart,” went on to ask “would foreign law, if applicable, such as the law of the U.S. or Germany, enforce the re-denomination or provide instead that the contracts must be honored in euros or are breached if not honored in euros? This is far from clear given the lack of precedents.”
Continue reading →

Let’s Get Down

Posted on by

The global interest rate cycle seems to be about to peak (of course at the ECB and in Japan it never really got started). The only thing which is surprising about this, is that anyone should be surprised. I am also convinced that Greenspan is nearly done at his end, and pretty much agree with Bill Gross, who “sees the Fed raising the rate on federal funds twice more, stopping at its August meeting at 3.5%”. I think one more quarter point is pretty much guaranteed (too much of a shock to the system if he doesn’t), the second one will be more debateable, just look what happened to the US bond market yesterday.

The Fed is really pretty much at the mercy of the ECB. Evidence for this? Well look at the impact of the Riksbank decision earlier in the week. I think you have to go back quite a distance to find a time when the financial world was waiting with baited breath to hear the latest prouncement from Sweden’s central bank governor. Or again, the entrails scrutiny on the BoE monetary policy committee minutes.

This process should have been fairly predictable, and once the Frankfurt/Washington consensus comes out of denial (that what is happening actually *is* happening) we can get down to the much more interesting little detail about *why* it is happening.

As Gross says “disinflationary forces are winning out”, now why would this be?

Sweden Acts On Interest Rates

Posted on by

Well Sweden has just put the cat among the pigeons. Taking advantage of its ability to apply an independent monetary policy, the Riksbank has decided to cut its base lending rate from 2.0% to 1.5%. The reason why is not hard to discern, apart from the reduced growth forecast for this year, the inflation rate is falling dangerously low, at just 0.2% year on year in May, dropping from a 0.4% y-oy in April and 0.5% y-o-y in March. Obviously Sweden is on deflation alert, and in fact a greater reduction (say 1%) might have been justified.

This is bound to spark all sorts of additional debate about the euro, and its advisability. Finland would be the best point of comparison here. The Finnish inflation rate was 0.6% y-o-y in May, but it has been hovering precariously near the zero level for the last month, anything which gave a sudden push to the disinflation process, like a sudden bust in commodity prices, would certainly clearly knock Finland over the line.
Continue reading →

Italy: Devaluation or Deflation

Posted on by

Italy is in recession. There is nothing extraordinary about this, as Donald Rumsfeld notoriously said ‘stuff happens’, and economies do have their ups and downs. But this recession is a little different, since it is structural and not cyclical. For the Italian economy to return to a better trajectory something has to be done, but what? Morgan Stanley’s Vicenzo Guzzo offers two alternatives: devaluation, or deflation (actually the way he puts the alternatives it sounds to me more like a case of: “with which instrument would you prefer I cut your throat sir, the stanley knife or the chain saw”?).

“If Italy intended to restore the pre-1999 competitiveness level, it would have to experience a 25% currency depreciation. While the euro is now down over 5% from the start of the year, such a large correction appears unlikely at this stage. In addition, the economy has steadily lost ground also vis-?-vis its euro area trading partners, as the breakdown of the trade data suggests. Euro depreciation would provide no oxygen on that front. In order to return to pre-1999 competitiveness levels, Italy would have to abandon the current exchange arrangements. To put it bluntly, it would have to drop out of EMU. A 25% devaluation is equivalent to what the economy experienced between 1991 and 1995. Exports scored double-digit gains in the aftermath of the realignment, but domestic demand fell heavily and debt services costs hit 12.5% of GDP. In a replay of those years, Italy would either default on its debt or run toxically tight fiscal policy. This is simply not an option, in my view.”

So Italy is caught. To devalue it would have to leave EMU. But then even if it could and did, it would go bust. So, on Guzzo’s reading, the only remedy left is substantial deflation, that is an ongoing reduction of wages and prices which would enable competitiveness to be restored. This sounds very much like the 1930’s and an Italy stuck with a modern version of the gold standard. It also sounds like going through a recession which could turning out lasting for a number of years, even if this was politically feasible it would be extraordinarily painful for many of those most immediately affected.

This, of course, is a question which is widely treated in the textbooks. So would anyone like to suggest a rival ‘escape strategy’?

The First Chink of Light

Posted on by

There is a very interesting article in todays Financial Times. For the first time an executive board member of the ECB – Lucas Papademos – has spoken openly about the difficulties presented by having a single monetary policy for such a diverse set of economies. In fact these comments take on more significance in the light of the fact that Papademos is vice President of the ECB, and widely tipped to replace Otmar Issing as Chief Economist when Issing retires.
Continue reading →

ECB Dispute Continues

Posted on by

I don’t like saying ‘I told you so’, but if you can spare the time to go through some of my posts, the ‘reading the tealeaves’ rate hasn’t been too bad lately. First there is the question of ECB rates, they need to come down. I started indicating this at the time of the May meeting. Then there is the trouble at mill story about the ECB, and then the negative consequences for the euro of a French ‘no’ (and here), all of which you were able to read on Afoe well before they got to be a commonplace in the mainstream press.

Well today there is more confirmation of my ‘crisis’ ECB hypothesis:

European Central Bank uncertainty about whether interest rates might have to be cut to boost the flagging eurozone economy has spilled into a semi-public debate among members of its rate-setting council.”

Hints by Jean-Claude Trichet, ECB president, and Otmar Issing, the bank’s chief economist, that the possibility had increased of borrowing costs falling have contrasted with comments by several national central bank governors on the committee.

The differences highlight the dilemma faced by the ECB. Economic growth, lacklustre for the past four years, has slowed again, and politicians are increasing the pressure for a further cut in borrowing costs. But excess liquidity and oil price increases are sounding inflationary alarm bells.

Incidentally speculations are already begining about Otmar Issing’s successor. I wish I could say for my part that his presence will be sorely missed. Doubtless he will be looking forward to all the extra time he can spend with his family.

Now, I have two more strong calls out (well three if you count the fact that I dismiss out of hand the inflation round the corner story, and have been doing so for the past three years): the EU commission will have little alternative but to try to strictly enforce the Stability and Growth Pact, and Alan Greenspan won’t be able to get very far with the ‘measured rate increases’. Inflation, collapsing dollar, China bust: I just don’t know how so many bright people can get things *so* wrong.

Prodi Strikes Back

Posted on by

I think one of the topics for next years election in Italy is just being decided. Romano Prodi (former President of the EU Commission) has just spoken out against Sinascalco. He is in favour of making cuts. Prodi is quoted as saying that:

“Credit downgrades will follow if there is not quick action in fixing the situation, and I do hope Finance Minister Siniscalco makes some decision……The government lost control of current expenditure. The situation is very serious.”

Prodi is about to become the whipping boy, having to go into an election with the ‘popular’ policy of making widespread spending cuts.

Incidentally,
Continue reading →

Maroni Hits Back

Posted on by

Roberto Maroni is back in the Italian press again today, and with another interview. This interview is in ilResto del Carlino. (Interestingly enough they are running an online poll, and the result was running at 51.7% euro to 48.3% lira). Unfortunately the interview is in Italian. I have translated a few extracts under the fold. The big issue that he draws attention to (and I was flagging this in an earlier post) is the apparent desire of Berlusconi not to commit himself if he can help it.
Continue reading →

Silence Is Golden

Posted on by

Well this clears up one niggling little doubt about last weeks ECB meeting. Remember my post – when no means maybe – about how Trichet saying ?I am not telling you anything that could be interpreted as preparing a rate cut,? was actually double talk, and what he meant was I am not telling you anything, but I am winking.

Well now that other ECB stalwart, Otmar Issing, has come to our rescue and explains: “Communication is not only about being explicit. It is also about not answering questions”.

So as Reuters Chief ECB correspondent puts it: “He did it through his silence”.

Sometimes I think it may be a good thing if some of our other institutional representatives (Jean Claude Junker?) could learn from his example.

Bottom Line: this has been done this way because, as I suggested it was politically and institutionally impossible to announce a change of policy at last Thursday’s meeting, a rate change can now be expected anytime after the next meeting.

In the absence of plan ‘b’

Posted on by

Many readers have been asking about the mechanics of any hypothetical ‘euro’ break-up, or indeed of what might happen if one country were to leave. Up to now, we have been told this is impossible, but clearly it is possible, and, however remote the possibility may seem (the order of 5% risk is the topical response) institutions in the financial sector cannot be without a plan ‘b’. In this context, this article, I found whilst idly noodling around the net, could be seen as informative. It is written by a software engineer for a magazine called Software Reality. The article’s title: reverse-engineering the euro.
Continue reading →