Yet another exciting night and , at least this time, the equities rally was based on something with substance. The news of course was this:
The US Fed took three actions this morning to support global financial markets: the first and by far most important was lowering the interest rate charged on its dollar liquidity swap lines with the ECB and other central banks from OIS+100bps to OIS+50bps, second it extended the availability of those facilities from August of 2012 to February of 2013, and third it has agreed with other central banks on creating swap lines whereby the Fed can lend foreign currencies to US financial institutions.
The major component of this is the drop in the OIS , and it will be 50bps cheaper for a European bank to get hold of US dollars. I explained yesterday that$US liquidity was becoming an issue and it is good to see that something has been done to address it. This is a system that was already in place and there is limited risk in this move. Equities, Soverign CDS ( except Greece ) and to some extent bonds are celebrating. Interestingly however, US banks aren’t joining the party with the TED spread continuing to rise.
I can understand the excitement to some extend, it certainly shows that their is some unity amongst global policy makers and co-ordinated and decisive action certainly has been missing from European economic landscape for quite some time.
However, this obviously only solves a small part of Europe’s current problems. Liquidity is an immediate issue for the banking system, but the long term issue is solvency caused by the imbalances that have grown, and continue to grow, within the European economy. Deflationary policies that have been pushed onto the periphery are making that worse, as we witnessed overnight:
European inflation remained at a three-year high and unemployment increased to the highest in more than 13 years, undermining an economy already hit by a worsening fiscal crisis.
The inflation rate in the 17-nation euro area held at 3 percent in November, the European Union’s statistics office in Luxembourg said in an initial estimate today. The region’s unemployment rate rose to 10.3 percent in October from 10.2 percent in the previous month, according to a separate report. That’s the highest since June 1998, before the euro was introduced, according to Eurostat.
Contrast that with Germany:
German unemployment dropped more than economists forecast in November, as companies’ resilience to the euro area’s debt woes showed no sign of cracking.
The number of people out of work fell a seasonally adjusted 20,000 to 2.91 million, the Nuremberg-based Federal Labor Agency said today. Economists forecast a decline of 5,000, the median of 33 estimates in a Bloomberg News survey showed. The adjusted jobless rate dropped to 6.9 percent.
The economic imbalances within Europe continue to grow, and as they do the transfer of capital out of the periphery and into the core continues. Under the single currency there is no stabilising mechanism to adjust for these capital flows so, even as the periphery losses wealth, it is not being compensated by greater competitiveness in order to try and re-capture that capital.
As I have explained many times previously under these circumstances what is required is a shrinkage of the competitiveness differential between nations which, outside some new discovery that the rest of the world suddenly wants, really means lowering the real average wage in the periphery. This is exactly what we heard from Juergen Stark overnight:
European Central Bank Executive Board member Juergen Stark said the only way for the region to exit its debt crisis is for governments to reduce budget deficits and embrace wage cuts and other structural changes.
“There is only one instrument left, which is adjustment in relative prices in wages, in salaries, in costs,” Stark said in remarks after a speech hosted by the Federal Reserve Bank of Dallas yesterday. “The ECB does not have the powers to support governments.”
I don’t disagree. If the euro nations are to stay together under the single currency with a non-intervening central bank then either the export driven nations must become more consumer driven and/or the credit driven more export focussed, preferably both. The issue I have with Mr Stark’s statement is that there is absolutely no creditable plan in place to make the transition.
What he is suggesting is that a country that is not currently export competitive should attempt to deflate its government and private sector in unison. This is highly deflationary and absolutely would lead to falling private sector wages which is what Mr stark is suggesting needs to be done. However, unless the private sector of the nation has a large savings buffer it will also very quickly lead to economic disaster as the private sector will be crushed between its falling wages, its existing debts to the finance sector and its new additional debts to the government sector. None of the nations Mr Stark is referring to have such a thing, and therefore Mr Stark’s austerity plan will not make any indebted non-export driven nation more productive while the existing level of debt exists.
Expecting an economy to deflate while still servicing its previously unsustainable debts, while many of its trading partners are also attempting the same thing, and while stronger economies in the same currency continue to drive for their own competitiveness is total economic lunacy. It simply cannot happen, and attempts to do so will lead to rises in unemployment, falls in industrial production and therefore an overall net loss because the debts will still exist. This is exactly what we are seeing in the European periphery and the contagion of that net loss is slowly creeping across Europe.
No amount of liquidity is going to solve that problem because it is very clearly one of solvency. If Europe wishes to continue down the path of driving forward economies via increased competitiveness then something has to be done to remove the existing debts. Until Europe can come up with a credible plan of how it intends to address this problem then nothing at all is really being fixed.