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Source: FT.com

Another step in the global trade war/currency crisis and U.S. dollar devaluation that we’ve been forecasting for the past decade. This Japan/China accord is the Asian trading bloc predictably coming together in the incipient global trade war.

But the incipient global equity Supercycle Bear Market will be accompanied with a rising“safe-haven” status U.S. dollar – up to DXY0 mid- to high 80s (which is why months ago we recommended taking U.S. dollar short profits in low-volatility, foreign-currency-based money market funds like ICPHX) – that will exacerbate the global trade war as each of the three global-trading blocs try to accelerate their export growth to reflate their recessionary economies. We fully expect the U.S. will become very frustrated and finally figure out to win the export growth game it will to succumb to a “last hurrah” formal devaluation ending the U.S. dollar status as the sole central bank reserve currency since WWII in some sort of Bretton Woods-like agreement under a replacement of Treasury Secretary Geithner.

See Economists React: China-Japan Currency Pact:

“China and Japan announced a wide-ranging currency accord on Christmas day that is expected to give the yuan a more prominent role in international trade. Among the measures, the two countries agreed to promote direct yuan-yen trade, rather than converting their currencies first to dollars, and also for Japan to hold yuan in its foreign-exchange reserves

-Barry Eichengreen, University of California at Berkeley:

I think the new accord is squarely in line with China’s strategy for internationalizing the yuan, which is to proceed in stages: first encourage its use in trade invoicing and settlement, then encourage its use in international investment, and lastly encourage its use as international reserves. They’ve been moving unilaterally to implement the strategy, most recently permitting offshore holders of yuan to invest in the Chinese stock market.

What’s new here is that they are working with and have the support of the Japanese government, which seems to be acknowledging implicitly that there will be a single dominant Asian currency in the future and that it won’t be the yen.

-Jeffrey Frankel, Harvard University

Before the yuan becomes a true international currency, let alone rivaling the dollar, it must become a normal currency. I would interpret the increased use of the yuan in China’s international trade as indicating movement toward becoming a normal currency.

If this new initiative with Japan were indeed to result in substantial bilateral trading between the yuan and yen directly, without intermediate use of the dollar, that would represent a big leap in international status, since almost all currencies have to go through the dollar as a vehicle currency.

Bottom line: This hastens a multi-currency world. But this is just one of 100 steps along the way.

WSJ: How would this affect the U.S. dollar and U.S. economy?

Internationalization of the yuan and a move toward a multiple currency system would by definition reduce the share of the dollar as an international currency. . . . If the yuan becomes internationalized, this will almost certainly be associated with an appreciation against the dollar. [Bob Bronson: After the global equity Supercycle Bear Market ends]

Overall, an appreciation of the yuan against the dollar would be good for the U.S. economy – especially during this current period of high U.S. unemployment, slow U.S. growth, and rock-bottom interest rates (though still nowhere near as important as U.S. congressmen think it is). Incidentally, I also think it would be good for the Chinese economy.

Of course, as with any exchange-rate change, there is always the flip side: the possibility of higher U.S. inflation and higher U.S. interest rates. [BB: Nope!]

Regarding a continuation, or acceleration, of the slow, 40-year trend [BB: It has only been 26 years since 1985] away from dollar hegemony toward a multiple currency system, it does have some negative effect, which I classify in four areas: loss of seigniorage, loss of business for U.S. banks and financial institutions, reduced convenience for U.S. businessmen (and tourists), and loss of geopolitical power and prestige. [That’s already happening, especially under Obama.]

But if these trends continue, the currency question will be more of a symptom than a cause. The cause lies in long-term fiscal unsustainability, imperial overreach and other U.S. policy mistakes, many of them attributed to the famous “partisan gridlock.” [More so due to the superior economic growth rate of the other two trading blocs since WWII, especially pan-Asia.]

Morris Goldstein, Peterson Institute for International Economics [His comments are the most sophisticated of the three]

The China-Japan initiatives will obviously increase the regional use of the yuan, although much depends on their scale and timing. That said, I don’t see them as game changers in the broader issue of if and to what extent the yuan becomes a serious rival to the dollar as the dominant global currency.

To do the latter, China would need to be willing to take some fundamental policy decisions, including changing its market intervention and sterilization strategy, undertaking interest rate liberalization, building a larger corporate bond market, reducing much further restrictions on international capital flows, and putting the banking system on a more market-oriented basis — to say nothing about avoiding a crash due to excessive investment in real estate.

Each of those policy choices involves tough trade-offs and reform on the whole package is likely to be some time down the road.

So yes, we are moving to a more multiple-currency world, but it is likely to be a slow process and is not likely to accelerate until China is prepared to give up much more to obtain much wider international use of the yuan.

I don’t think the US should either encourage or discourage it; it should allow the market to choose. Besides the international role of the dollar depends much more on what we do (e.g., U.S. fiscal reform) than on these kinds of yen/yuan initiatives.

I think the international role of the dollar is a moderate plus for the U.S. but this latest initiative is not something the U.S. needs to react too; this is a long-distance race not a sprint.

–Bob Davis

G4 Central Balance Sheets /European Contagion
December 17, 2011
David R. Kotok

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“A picture is worth one thousand words.” We present 13 pictures to describe the title subject, on our website, www.cumber.com.

Scroll to the two chart stacks. In the first, we reflect changes in the balance sheets of the G4 central banks. The G4 central banks are the Bank of England (BOE), the Bank of Japan (BOJ), the Federal Reserve (FED), and the European Central Bank (ECB). Other central banks are important; however, the G4 comprises the four central banks managing the currency blocks of nearly 85% of the capital markets that trade in the world. Other large capital markets are linked to one of them. Therefore, China’s central bank is not shown, because China manages its currency exchange rate via a peg to the others.

If you capture the G4 transactional changes, you get most of the financial impacts of the world. Paging though the G4, one sees the following information leap from the charts. The central bank balance sheets of the BOE, BOJ, and ECB have all recently increased in size. That of the FED has not. In fact, the FED’s balance sheet is actually slightly smaller than it was a few weeks ago.

Why is two weeks so important? Two weeks have elapsed since the central banks announced a coordinated activity on November 30th. Notice how those balance sheets have expanded; note also where they have expanded. We have color-coded the various compositions of both assets and liabilities of each balance sheet. The recent growth in total assets of the four central banks is clear.

The one central bank balance sheet that did not grow is that of the United States’ central bank, the Federal Reserve. Notice what happened in the last few weeks when the others expanded and the FED did not. The US dollar actually started to strengthen against other currencies, particularly the euro. As we have been writing and stating for some time, there is a relationship between the foreign exchange markets and changes in the exchange rates among and between the currencies, and the actions of the central banks involved with those currencies. We see the reaction in the foreign exchange market almost at once. A central bank takes an action, makes a statement, initiates a policy – whatever the case may be – and the foreign exchange markets readjust the ratios among and between the currencies. That is apparent in the past two weeks, and it is apparent in an examination of those four central bank balance sheets.

Cumberland has stacked the four central bank balance sheets so they can be flipped easily by any interested party. We will update them regularly. The other stack of charts shows the “good” countries and the “bad” countries in the Eurozone. And it shows the spreads of interest rates between the good countries and the benchmark German 10-year sovereign debt instrument, known as the “bund”, and the spreads between the bad countries and the bund. Notice how the spreads peaked in almost every case a few days prior to the November 30th announcement of the change in central bank policies. We speculate that someone somewhere got wind the policy change was coming and may have made themselves a lot of money on that trade.

G4_Charts

More after the jump

Read the rest of this entry »

Time.com – As the Crisis Refuses to Calm, Scenarios of Euro Collapse Appear

French researcher Emmanuel Todd argues that though the implosion of the euro would produce a period of economic pain, panic, and instability, he says that shock wouldn’t last as long as some predict (18, maybe 24 months), before companies and governments picked up and moved on. And because many euro countries would be starting anew after having brushed off huge amounts of debt through various degrees of default, Todd argues the post-euro economies could be re-constructed on more solid fiscal foundations. Another consequence of such default, Todd says, would be freeing economies and governments from control of what he calls the “oligarchy” of mega-rich investors whose fortunes and interests drive and shape bond markets—and whose gain through safe government securities have influenced political leaders into building up huge public debt in the first place. Another benefit for European nations, Todd says, would be throwing off the domination of Germany, which he describes as dysfunctionally psycho-rigid, and so focused on its own national interests that it no longer cares about ruining its euro partners. Burning the rot from a teetering house, Todd suggests, will be hard and grim work, but at least leave enough of a sanitized structure to rebuild from.

Reuters.com -What If The Euro Collapses?
Swiss wealth manager Sarasin reckons the impact will be a meteor striking the earth and offers following scenarios:

A run on the banks by savers keen to put their money into a core euro country would bring down the banking system of the departing country overnight.
Companies and private households would not have access to loans, nor would they be able access any more cash.
The state, which in this situation should support the banks, would be bankrupt as well. Financial markets would deny it access to funding.
The new currency, once it is introduced, would depreciate by between 30% and 50%, which would multiply the government’s debts.
The depreciation would lead to imported inflation and trigger trade union demand for compensation, setting off a hyperinflationary spiral.
The bankruptcies of banks in Southern Europe would bring about the downfall of their northern counterparts because the latter have lent them large sums of money in the belief that monetary union would last forever.
Anticipating an appreciation, huge capital flows would drive up the new Deutschemark. Many medium-size companies would become uncompetitive overnight.

The Wall Street Journal – ‘Fiscal Compact’ on Euro Set for Mid-2012

A new “fiscal compact” designed to mend flaws in the single European currency’s framework should be completed in the first six months of next year, European Commission president José Manuel Barroso said Wednesday. “We are going to hopefully conclude negotiations for a new fiscal compact during the Danish presidency,” Mr. Barroso told the European Parliament. “The crisis is not yet behind us, there’s a lot of work ahead.” Denmark takes over the European Union’s six-month rotating presidency from Poland on January 1. Germany believed that the agreement of new tougher fiscal stability rules in Europe would be enough to calm down the financial markets but not all other countries at last week’s EU summit agreed, Italian Prime Minister Mario Monti said Wednesday in an address to the Italian Senate. More systematic fiscal rigor is “essential” and the pledges made by 26 EU members last Friday will boost the credibility of public finances in the region, Mr. Monti said.

The Wall Street Journal – Euro Falls Below $1.30

The euro took a hit Tuesday after German Chancellor Angela Merkel expressed her opposition to raising a €500 billion ($652 billion) lending limit for the permanent euro-zone bailout fund, the European Stability Mechanism, which is due to come into operation in July 2012. “The comments contained no surprises, but came at a bad time,” said Dai Sato, senior vice president of the foreign exchange division at Mizuho Corporate Bank. Traders said euro bearishness could persist unless Germany and the European Central Bank step up their contributions to efforts to put an end to the crisis. “But such changes are unlikely to occur soon,” Mr. Sato added. The euro will likely come under pressure against the yen, said Junya Tanase, chief currency strategist at J.P. Morgan in Tokyo, adding that “there’s a chance it may fall below ¥100.” That would be a new 10-year low, breaking the mark of ¥100.77, set in October.

Source: Arbor Research

Bank lending in China slowed to Yuan562.2bn, as compared with Yuan587bn in October. In addition, M2 rose by just +12.7%, the slowest since May 2001 (source Bloomberg). There is no doubt that the Chinese authorities will ease further, though I remain sceptical as to whether it will be enough, given the structure and serious imbalances of the economy;

Inflation in India (the wholesale price index) declined to +9.11% in November as compared with +9.73% in October, though slightly higher than the consensus of +9.02%. However, lower inflation (which is expected to continue) will enable the RBI to ease monetary policy in the New Year (the last of the major S/S E Asian countries to do so).
Analysts expect the RBI to be on hold this week (16th December), following recent statements by the RBI. Bond yields continue to decline and the Rupee (down 16% against the US$ YTD) weakens further – a trend I expect to continue;

Putin may dump Medvedev in an attempt to bolster his Presidential aspirations – he remains the favourite to regain the post. Russian’s have been critical of the proposed job swap. The move may help Putin a bit, but his position, in particular in dealings internally and with foreign countries will be weaker. Currently Russia needs a US$100bpd oil price. With the expected increase in spending ahead of the Presidential elections, that will increase to maintain a balanced budget. Expect a weaker Ruble, uncertain equity markets and continued capital flight It is widely believed that Russian Oligarch Mr Prokhorov’s bid for the Russian Presidency has been sanctioned by Putin, who wants to allege competition for the role – children’s games basically;

Continued problems in Hungary are affecting Austrian and Italian banks
- basically Hungarian homeowners borrowed in Swiss Francs, rather than HUF’s to get lower interest rates, forgetting the currency mismatch – Oops. Other CEE homeowners did the same eg in Poland. CEE will remain a HUGE risk for Euro Zone banks and the EU. Watch this one;

There is continued speculation that the SNB will raise the effective Euro/CHF peg. Swiss investor confidence results were negative and, in addition, exporters are really feeling the pressure. However, these rumours have been around for some time now, I accept;

The German investor confidence index (the ZEW) came in at -53.8 in December, slightly higher than November’s 55.2, though well below the average of around 25. The construction, component was particularly strong, though private domestic consumption is holding up well. The ZEW economist suggested that Germany GDP may contract in the 1st Q next year, but recover thereafter, with GDP of +0.9% forecast for 2012. Exports are expected to decline modestly. Basically a better than expected report, particularly given recent events, though I remain sceptical;

The Bundesbank has agreed to providing funds to the IMF, as long as other countries (France, the UK, US and China) do so as well. Whilst these funds cannot be earmarked for Euro Zone countries, they certainly will be heading that way;

Mrs Merkel has stated that the size of the ESM would be capped at E500bn, with no leverage. Her comments came ahead of a key speech to the German Parliament in respect of the bail out funds, so not unexpected. However, the funds available to the EFSF/ESM is simply not enough. The proposed E200bn to be provided to the IMF by EU countries,to be on lent to Euro Zone countries, is fraught with difficulties – basically where will the money come from;

One key issue – German officials are now stating that (both) the size of the EFSF/ESM will not be increased and that Euro Bonds are not on the cards “AT THIS STAGE”. At this stage is the key message. Merkel has to bring her people around – that’s the issue. How long will it take – too long. As a result, another Euro Zone crisis is very likely, which will force Euro Zone politicians to ultimately move towards enabling the ECB to buy bonds aggressively and, in addition, employ QE. I remain convinced as there is no other alternative;

The German cabinet has reactivated its bank rescue fund (created post
Lehman’s) and, indeed, has agreed to increase its size to E480bn, from 360bn previously. The EBA has mandated that German banks must raise E13.1bn by June next year – still, far, far too little;

The WSJ quotes the European Council’s President Mr Rumpoy who expressed concern that last week’s political deal amongst the Euro Zone countries may be difficult to implement into a “watertight legal pact”. In addition, as the deal involves bilateral agreements, which was the fall back position, given the UK’s veto to a new treaty, the role that the European Commission can play must be suspect;

Italy sold E3bn (the maximum) of 5 year bonds today at a rate of 6.47%, as opposed to 6.29% on 14th November – however, the highest rate since 1997. Bid to cover was 1.42, as opposed to 1.47 previously.
Markets remain concerned as to PIIGS debt, though the auction results were close to expectations, possibly marginally worse;

Emails suggest that James Murdoch may have been “economical with the truth”. The content of the emails sent to Mr Murdoch reveal that there was widespread phone hacking at the News of the World. Mr Murdoch denies having read the emails !!!!!. Whatever, News International’s position will be under pressure, both in the UK and the US;

UK unemployment rose to a 17 year high. With a weakening economy, the situation will deteriorate further. Average earnings in the 3 months to October declined to 2.0%, from 2.3% in the previous 3 months, which will enable the BoE to increase its QE programme (a further £100bn -
£125bn) in Feb/March;

US retail sales rose by only +0.2% in November, lower than the +0.6% forecast. However, October’s data was revised upwards to +0.6%, from
+0.5% previously reported. Car and truck sales rose by +0.5% to an
annual rate of 13.6mn, the best since August 2009. Sales of electronics increased by +2.1% and on line retailers were up +1.5%.
Lower petrol prices reduce petrol station sales by -0.1%, though clearly will help in terms of disposable income;

The FED reported that the US economy “has been expanding moderately”, though expressed concern about slowing global growth, which “continue to pose significant downside risks”. Bernanke added that unemployment would decline “only gradually”. He did not announce any new measures, which was taken negatively by markets, though the message contained in his statement suggests that the FED has a bias to easing further, in some way. Still believe that further QE is likely.
The market reacted negatively – traders expected further moves towards easing – totally unrealistic at this stage;

The race for the Republican nomination to contest for the Presidency is in shambles. Allegedly Ron Paul is ahead in Iowa, Gingrich is gaining support, whilst Romney’s support is weakening. The only winner out of this is clearly Obama;

CME’s Mr Duffy’s testimony to the Senate Committee implies that MF Global were effectively “cooking the books”. He also challenged Mr Corzine’s testimony. This is going to get really messy. It remains staggering that the senior management of MF Global continue to allege that they do not know where client money went;

Summary

Markets reversed early gains on a much weaker Euro yesterday and disappointment that the FED did not announce further easing measures yesterday – they remain weak today. Personally, I believe the FED said more than enough, though am not surprised by the Euro’s weakness.

Germany continues to block measures re the Euro Zone, though the rhetoric is changing – officials are using the line “at this stage”.
This slowly, slowly process towards (the inevitable) QE/ECB bond buying will cost Germany far, far more ultimately. Another crisis looks more and more certain.

Next year, the composition of the ECB changes, with the appointment of the Frenchman Mr Coeure. These representatives will be pushing for more aggressive bond buying/QE by the ECB. To put the issue in context, the FED has bought US$2tr of bonds, the ECB only approx US$325bn and the BoE (once the current programme has been completed US$420bn, with a further increase of US$150bn – US$185bn+ certain).
Furthermore the ECB continues to sterilise proceeds. Complete and utter madness.

The Euro is trading below E1.30. Further weakness is very likely. Cant see any reason to buy the markets at present – indeed, short Euro against the US$, and short the indicies seem to be the right move.

Sorting Out the Euro Mess
John Mauldin
December 12, 2011

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I had the pleasure of spending the morning and part of the afternoon today with Louis Gave and Anatole Kaletsky at a seminar here in Dallas; and we shared a long lunch, where Europe and China were the topics of conversation. So, with their permission, here is their latest “Five Corners,” in which Charles Gave and Anatole Kaletsky discuss last week’s summit, and then engage in an internal debate about whether Italy really has a significant trade deficit with Germany. As I expect from GaveKal, it’s not your typical analysis. And since I have to run to dinner – and glean more insights from their team (there will be homework when I get back!), this introduction to Outside the Box is short, and we can jump right into today’s piece. Have a great week.

Your feasting on information analyst,

John Mauldin, Editor
Outside the Box

JohnMauldin@2000wave.com

Why Pennies are economically inefficient and should be abolished.

http://blog.cgpgrey.com/death-to-pennies/

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Terribly amusing . . .

The UK is as isolated as someone left on the dock in Southampton as the Titanic sailed away.

-Terry Smith of Tullett Prebon

via FT’s Alphaville

The euro zone has only a matter of weeks to take steps that will ensure the common currency’s survival, former U.K. Prime Minister Tony Blair says in an exclusive interview with the Journal’s Managing Editor, Robert Thomson.

12/1/2011 5:36:22 PM

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The Financial Times – The terrible consequences of a eurozone collapse

What happens if the euro collapses?

A euro area breakup, even a partial one involving the exit of one or more fiscally and competitively weak countries, would be chaotic. A full or comprehensive break-up, with the euro area splintering into a Greater Deutschmark zone and about 10 national currencies would create pandemonium. It would not be a planned, orderly, gradual unwinding of existing political, economic and legal commitments. Exit, partial or full, would likely be precipitated by disorderly sovereign defaults in the fiscally and competitively weak member states, whose currencies would weaken dramatically and whose banks would fail.

If Spain and Italy were to exit, there would be a collapse of systemically important financial institutions throughout the European Union and North America and years of global depression.

Comment:

Looking at the chart of the euro above, we can’t help but notice a complete lack of trend one way or another.  Given all the stress in Europe, it is amazing that the currency is relatively unchanged on the year.  After all, the Intrade.com markets are pricing in a 63% chance that at least one country drops the euro by the end of 2014.  So why hasn’t the currency dropped appreciably in anticipation of such an occurrence?

The problem with this line of reasoning is that nobody knows what a “new euro” might look like.  Will countries such as Greece be kicked out of the euro, leaving a currency that more closely resembles the old Deutsche Mark?  This would likely result in a rally.  Or, will Germany and their more fiscally sound counterparts exit the euro, leaving the PIIGS to fend for themselves?  Barring a historic precedent for such a dismemberment, nobody is entirely sure what the euro might look like in such an event.  Until leadership in the EU resolves these issues, we would not be shocked to see the euro continue to trend sideways as it has most of this year.  Will the summit currently underway provide any of these answers?  Tune in tomorrow to find out.

Source: Arbor Research