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.

Goldman Had A Perfect Quarter

This may sound like a ridiculous headline, but it appeared in the Wall Street Journal today. (See http://online.wsj.com/article/SB20001424052748703880304575236132462861088.html#mod=todays_us_money_and_investing.)
The reason for the headline is that the Goldman Sachs traders made money every day the firm traded in the first quarter of 2010!

The article states: “Traders raked in more than $100 million daily for 35 days and made no less than $25 million daily during the rest of the three-month period, according to the regulatory filing on Monday. The streak was a first for the Wall Street firm, which typically loses funds on at least a handful of days in a given period.”

On that basis Morgan Stanley had a more typical quarter. Morgan Stanley lost as much as $30 million daily on four days during the quarter. The other days, well, they made money far in excess of the losses.

What the government takes away with one hand the government gives back with another.

While the government chastises Goldman and its management and sues it for securities-fraud, the Federal Reserve subsidizes Goldman with super-low interest rates.

During the first quarter of 2010, Goldman could borrow money for up to six months for 20 to 50 basis points. They could lend these funds out for almost 400 basis points, RISK FREE. And the Federal Reserve promised them that these spreads would continue to exist for an “extended period” of time!

Goldman Sachs should send Mr. Bernanke a big basket of fruit accompanying a big “THANK YOU, MR. BERNANKE” card.

Wish I could play this game!

And, now the European Central Bank seems to be getting wise to the game. And, our Federal Reserve system is going to support the ECB through currency swaps!

And, then the figures come in on Fannie and Freddie! And, with all the new spending programs coming from the Obama administration it is hard to take seriously the feeble coins that are tossed to the study of how to get the federal deficit under control. Official forecasts place the federal deficit under $10 trillion for the next ten years. I still believe that deficits will accumulate more toward the $15 trillion to $18trillion range.

The Fed is going to “tighten up” in the face of all this junk? Or, will they pull a “Trichet”. Or, has Jean-Claude Trichet, the Chairman of the ECB, pulled a “Bernanke”?

The problem, as I have written many times before, is that when a nation puts itself into a position like the United States (and many of the European nations and England) finds itself, there are really no good choices to left for it. However, the tendency is that once a nation finds itself in such a hole, they continue to dig deeper as the United States (and the European community) is now doing.

Peter Boone and Simon Johnson write in the Financial Times this morning about “How the euro-zone set off a race to the bottom.” (See http://www.ft.com/cms/s/0/5d666d5a-5c69-11df-93f6-00144feab49a.html.) The EU dug its own hole and now they continue to dig the hole deeper and deeper.

The Euro-zone system “encourages “a race to the bottom”—led by governments in smaller countries, which relax fiscal and credit standards to win re-election.”

I would add that this claim could be leveled against the United States and Great Britain just as well as they raced to provide more and more social services and housing to the electorate in order to get re-elected and justified borrowing massive amounts of money, both domestically and internationally, through Keynesian arguments that there was an infinite supply of funds available to governments.

The governmental emphasis on generating huge deficits, on financial innovation and creating massive incentives to inflate the amount of credit outstanding, changed the whole environment of finance. And, of course, the very people that created this environment, the various presidential administrations of the past fifty years and their co-conspirators in Congress, now condemn what they have created and sue it. Yet, they also continue to underwrite it through bailouts and subsidies like the monetary policy of the Federal Reserve called “Quantitative Easing.”

All I can say about the quantitative easing is that there must be a very large number of the remaining 8,000 “small” banks in the banking system that are in very serious financial difficulty for the Fed to continue to maintain this policy and subsidize the further growth of the “big” banks!

There are no good decisions left. And, I fear, that the ultimate resolution of this situation, as Boone and Johnson argue, is for these profligate nations to default, “either through repudiations or inflation.”

However, things don’t stop here. What this situation points to is the weakening of the influence of the Western nations, especially that of the United States. Given the current situation, why should China bow to any wishes made to it by the United States government except to those that are particularly in their interest? (See my post, “Why Should China Change?”: http://seekingalpha.com/article/193689-why-should-china-change.) The same applies to India (see a very interesting article in the Financial Times this morning, “India: The Loom of Youth”: http://www.ft.com/cms/s/0/8aefdf1e-5c68-11df-93f6-00144feab49a.html) and Brazil. The United States (and Western Europe) have made these countries relatively more powerful and independent. And, given the current position of the United States (and Western Europe) why should the countries be generous to the dominant power in the world?

The world has changed over the past fifty years and the United States has contributed significantly to its own relative decline. (Watch this played out in future meetings, like that of the G-20.)

And, it has contributed to Goldman being perfect!