Here’s an unconventional reason why Europe won’t throw monetary prudence away in a large way: because the U.S., I hypothesize, doesn’t want it to do so.
While much too much is hidden in finance today, it appears that we can rely upon the broad concept that Europe’s private and public borrowing and lending sectors have a shortage of real capital. Thus the Fed has lowered its lending rates and in a sort of “make it up on volume” concept of a discount retailer, has been “rewarded” with massive demand for its cut-rate lending facilities from Euro-land banks, mediated through the European Central Bank (ECB). So, in that sense, the U.S. holds the whip hand. The U.S. has reasserted itself as the clear global superpower. China? No way, anytime soon. China was even kicked out of its demonstration construction project in Poland months ago, as its company performed so badly. It may or may not be the “American century”, but it sure looks to me as if it’s the American decade, stagflation or no.
President Obama has called for a large increase in U.S. exports. If the ECB is felt to be throwing caution to the winds by engaging in large-scale asset purchases of sovereign debt that the markets are viewing as troubled, this will tend to lower the value of the euro vs. the USD. Lots more euros, no new dollars (unless the Fed massively surprises the markets by announcing a parallel balance sheet expansion).
So my guess is that part of the deal between the U.S. and Euroland is that we help them out in their moment of need, but we’re not going to wear a hair shirt for them and thus we want a relatively strong euro and do not want the ECB to create “too many” new euros. Just a guess, of course.
In the general field of failure, tomorrow could be an interesting day on the Hill. Jon Corzine is scheduled to appear under subpoena before the House Agricultural Committee, with proceedings beginning at 9:30 A.M. We will see if he invokes the protections of the Fifth Amendment.
The near-insolvency of Greece, rumblings of which first came to public attention about two years ago and which have helped lead the euro-zone to its current status, and the insolvency of MF Global, with the still-unexplained disappearance of hundreds of millions of client funds, are but two of the unresolved problems that could have important and unpredictable outcomes.
It will be a surprise to no stock market participant that the S&P 500 has been challenging its declining 200 day (40 week) simple moving average with a reverse head and shoulders formation that looks very much like that of 2010. A year ago, that formation was resolved to the upside along with massive breakouts in gold, silver and oil. In 2008-9, similar chart patterns repeatedly failed.
It continues to strike this observer that on a risk-reward basis, the U.S. stock market has a disproportionate downside risk from a mere mild recession (using NBER’s terminology)- which would definitely be considered a new recession, not a “double dip”. If that occurs, I would expect market expectations to be for the Fed’s ZIRP policy to extend well beyond 2013, and thus intermediate-term bonds would likely rise in price (decline in yield), and this would include high-quality debt instruments other than Treasurys (yes, of course, Treasurys are “high-quality”: Mr. Buffett says so). On the other hand, if economic activity should largely meet (or exceed) the bulls’ expectations, then there probably would be carnage in the Treasury market as yields would rise a good deal. But in that scenario, the risk premium from municipal bonds would shrink or go away, and they could stay even in yield even in that situation. In line with this view that for taxable assets looking for a home people should consider munis, the charts of muni bond funds are looking as good as the charts of silver and the SPY are looking stressed. Even on “risk on” days, these securities (see NIO and VWLUX for two of many) have been holding even, and they have been rising on “risk off” days. This, by the way, is the pattern they exhibited in the 2001-2 bear market period, as opposed to the way they functioned as risky assets during the 2008 crash period.
Thus, munis are so far showing the phenomenon of alternation of cycles, and are acting as they did two economic cycles ago rather than as they did in the last stock down-cycle. As readers know, I am thinking that the economy is different from 2010, when a faltering recovering was rescued by a timely QE 1.5 beginning in August, which of course was succeeded by QE 2 beginning seamlessly as QE 1.5 ended. In contrast, while the Fed loans to the ECB and Operation Twist have some degree of easing characteristics, they are not financial bazookas unlike QE 1-2, and thus my guess is that the economic downturn that began in 2007 and has in most Americans’ eyes never ended is at higher risk of intensifying than is priced into the stock and commodities markets.
In these times where Americans have little understanding of exactly why the Greek government is quite so insolvent and what the real condition of the major European banks is, and in which we have no idea why MF Global’s failure took segregated client funds with it, we can all understand that electric power and water and sewer are essential services that will be in demand for the length of the longest-duration bond you might wish to own, and which are services that are even more important to most people than i-anythings. Thus, with protection against much higher tax rates on investment income/capital gains that are scheduled to arrive January 2013, and with protection against the possibility of rising taxes on marginal earned income, high quality tax-free U.S. municipal bonds may offer some shelter from the storms.