The Euro is a Red Herring!!!

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“The Euro is falling!” they scream on CNBC.  Who cares!? Not me.  It’s supposed to be falling.  They’ve got too much debt and slowing growth.  EUR denominated rates should come down and there is growing risk the European Monetary Union will break up.  By themselves, these facts (assertions?) do not have a great deal to do with the US.

The far bigger problem, and the driving force behind global asset price drops, is the rise in dollar funding rates.  The easiest way for you and I to track it is the TED Spread.  You can also just look at a graph 3 month LIBOR. How does this graph square with Bernanke’s insistence that the FED will be on hold for while? Who, in their right mind, would hike rates in the face of a global financial crisis? Short term dollar interest rates, however, are rising!!!

The really scary part – the part causing global stock markets to fall – is there’s not much the Fed can do about it. The Fed’s monetary tools are limited to USD denominated assets. Do you think the Fed is going to monetize Sovereign European debt? When it comes to this part of the crisis, the Fed might be out of bullets.

That leaves someone in Europe to respond. As I’ve discussed before, however, there is no one institution in charge in Europe.In the US there is one government making decisions (good or bad) about monetary and fiscal policy.When the shit really hit the fan after Lehman, someone had the authority to buy up the bad debt and thereby stabilize the banking system. In Europe, I’m not really seeing this happen. I keep hearing random ministers blather about defending the Euro (red herring!!). One time, two Sunday’s ago, I heard that the $1 trillion fund was going to buy some bonds as well. I have not heard it since, and that’s the problem.

The fact remains, European banks are not getting the support they need in the form of off-loading crappy sovereign bonds. As a result, interbank risk remains the growing problem as evidenced by rising interbank rates; including US rates. This has nothing to do with the EUR/USD exchange rate.

When people focus on the Euro, it’s like an ER doctor treating a gunshot wound by focusing on cleaning up the blood on the floor. To beat the Hell out of the metaphor: no one in Europe is telling me how they are going to remove the bullet (buy the crappy bonds from European banks) and stitch-up the wound (serious fiscal reform in the PIGS). In all fairness, there is talk about “austerity programs” in Greece, but there are also riots in the streets; i.e. no one is sure there’s the political will for true change.

So, the headline you’re looking for to see any light at the end of the tunnel is for some muscular coalition in Europe that agrees to buy the sovereign bonds. The problem here is, who?
Let me ask you, wherever you sit in the world, do you feel like buying Greek sovereign bonds right now? Would you reelect a leader who did? If you answer ‘no’ to both, then you understand why this is a very, very difficult problem to fix.

Key takeaways:

  • Falling EUR is a symptom at best and a complete Red Herring at worst.
  • Sovereign debt risk is the major problem for European Banks.
  • The connection to the US - and therefore the rest of the world - is the US  dollar funding market (higher LIBOR rates)
  • Europe appears to be either rudderless, politically paralyzed, or both.
  • The Fed is largely out of bullets (e.g. hard to cut short term rates below zero and it’s hard to convince markets to lend to European banks).
  • Cash is king and the best kinds of cash, in order, are: 1) Yen and 2) USD.

Good luck out there.

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Posted In: CNBCRumorsForexGlobalEconomicsIntraday UpdatePersonal FinanceTrading IdeasGeneralausterity programBernankeCNBCdollareuroEuropean Monetary UnionGreeceInterest RatesLehmanLIBORTED spread
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