Tuesday, April 5, 2011

The Euro: Trichet versus Bernanke

How important is reputation in monetary circles?

I believe that the general movement in the value of the Euro relative to the United States dollar over the past seven months or so gives a picture of how the reputation of a central banker, when compared with his peers, can be reflected in financial markets.

The particular comparison here is between Jean-Claude Trichet, president of the European Central Bank (ECB), and Ben Bernanke, chairman of the Board of Governors of the Federal Reserve System. The winner has been Trichet; the loser Bernanke.

In general, the “bad” news has been coming out of Europe, the fiscal problems in Ireland, Greece, Portugal, Spain, and, if we want to get even more picky, Italy and France. The fiscal crisis really began to heat up at the beginning of 2010. The “crisis” caused another “flight to quality” in foreign exchange markets, that is a movement into the United States dollar and this is shown in the accompanying chart. The U.S./Euro Foreign Exchange Rate dropped early in 2010 and bottomed out in June as the European Union seemed to be getting its act in order.

Notice that the value of the Euro really begins to rise again in early September. This marks the time just after Chairman Bernanke announced to the world that the Federal Reserve was going to enter into another round of Quantitative Easing, now fondly referred to as QE2. (http://seekingalpha.com/article/222704-bernanke-in-the-hole)

The rise in the value of the Euro against the dollar was almost 12 percent throughout the fall.

Still the Europeans dawdled and the dollar strengthened again as money left Europe for “quality” assets.

Trichet took care of this after the March rate-setting meeting of the ECB. At that time he sent out strong signals that the ECB should raise its target interest rate at the April meeting.

So, after a decline of something less than 8 percent following the peak value reached in early December, the Euro has climbed another 9 percent or so, even in the face of continued concerns about the health of the banks in these countries and the revelations about the fiscal condition of some of the governments trying to get their budgets back in order. These concerns were accompanied by several downgrades of some sovereign European debt.

“As traders continued to bet the European Central Bank would pull the trigger on the first of several interest-rate increases on Thursday, the euro hit five-month highs against the dollar,” (http://professional.wsj.com/article/SB10001424052748703806304576242362812362214.html?mod=ITP_moneyandinvesting_3&mg=reno-wsj).

Thursday is the meeting of the ECB. The bets are obviously on the ECB raising its target interest rate.

Trichet has a credibility that Bernanke does not have. Trichet is standing up for some kind of monetary constraint. Bernanke keeps throwing spaghetti against the wall.

Trichet has moved ahead of events. Bernanke has always missed the turn of events and lagged sadly behind resulting in the need to over-react to situations.

But, this reflects the whole position in the United States. There is no one around that seems to have any credibility for establishing any financial or monetary discipline in the United States government. Why should anyone want to bet on the United States government establishing some kind of responsible budgeting when projections are for the government debt to increase by as much as $15 trillion over the next ten years? And, why should anyone want to bet on the Federal Reserve system controlling inflation during this time period when the leader of the central bank has injected $1.5 trillion dollars of excess reserves in the banking system and is always “late to the dance”?

The market is taking Trichet at his word. The market is also trusting his determination.

The United States? Maybe Paul Ryan, chairman of the budget committee of the United States House of Representatives, can build up some reputation in financial markets that someone in America is going to draw a “line in the sand.” Right now the financial markets are not betting on his success.

So for now, Trichet…and the Euro…seem to win.

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