Euro to confound experts and rally?

[murphy_p_t]

I'm wondering if the idea that the Euro will collapse is over-subscribed...and could surprise all the pundits and rally strongly?

Say Greece leaves Euro...might this be hugely bullish for the Euro? They could fully write down debt and start from a firm foundation?

I ask for two reasons that come to mind. The first is how the US Treasuries rallied strongly last year...when the main topic of conversation was reaching the debt ceiling and some claiming the US could default on bond payments. I didn't read any pundits that suggested that Treasuries was the place to be last year.

Secondly, just the idea that the "trade" is crowded...and maybe a breakup of Eurozone is already priced in to the exchange rates.

[moda0306]

murph,

Judging by how almost everyone (including me) was completely wrong about how the debt ceiling fiasco would affect US treasury bonds (and again how the S&P downgrade would affect them), I feel like any analysis of the Euro and what will happen should probably be taken with a grain of salt, but I am dumbfounded that there hasn't been more analysis of this stuff.

Not only did people get the treasury call 180 degrees wrong, they almost tried to brush it off as just a slight miscall and move on.  It seems like nobody sat and really analyzed how something so counterintuitive to them could have happened.

And really, once you absorb some MMR/MMT observations, the treasury performance was pretty understandable and not all that deeply complex.  However, the Euro breakup could plausibly happen about 100 different ways, some much more likely than others, and some resulting in VERY different results for different financial assets denominated in the Euro, including the raw currency itself.

I would love to see an infographic or decision tree analysis done on this topic, for digestible infotainment.

[MediumTex]

The euro experiment will either end with a single political authority ruling all of Europe, or the currency function will be restored to the current individual sovereign political units that make up the EU.

What they have now is structurally unsustainable.

What I fear is that in the interest of maintaining the euro you will see calls for a single political authority to rule all of the EU, and this would IMHO be a disaster that would set the stage for multiple rebellions and insurrections down the road.

Any way you cut it, though, the current structure of the EU is based upon some naively optimistic assumptions, among them that a group of nations that have fought innumerable wars amongst themselves in the last few hundred years are going to magically be able to coexist within a form of economic union that has never existed any time or anywhere in history. 

[Gumby]

Say Greece leaves Euro...might this be hugely bullish for the Euro? They could fully write down debt and start from a firm foundation?

If Greece left the Euro it would be terrible for the Euro. You can't just write down hundreds of billions of over-leveraged bad Euro loans and expect everything to be fine. Lehman Brothers was a $650 Billion company, and we are still seeing the effects of its over-leveraged vaporization.

I ask for two reasons that come to mind. The first is how the US Treasuries rallied strongly last year...when the main topic of conversation was reaching the debt ceiling and some claiming the US could default on bond payments. I didn't read any pundits that suggested that Treasuries was the place to be last year.

If you were reading MMTers at the time, you would have seen those calls for Treasuries — which seemed unbelievable at the time. People thought they were crazy.

When asked if a rating downgrade would lead to skyrocketing interest rates, MMTer, Mike Norman said:

There is no issue of solvency. There cannot be an issue of solvency. The United States is always going to be able to pay its debts. I think a lot of what's going on here is fear mongering. Look, if you look at Japan, for example, which had its credit rating downgraded several times by the rating agencies the ten year yield on the Japanese Government Bond — the equivalent of our Ten Year Treasury — is yielding 1.5%. So the interest rate will be unaffected.
Source: http://youtu.be/4HJ54RRB7OU

Norman, and other MMTers, believed that a rating downgrade would generally lead to lower rates over time. For instance a month after appearing in that video, he clarified his position on rates continuing to fall...

The yield on 3-month T-bill fell to a record low today of .02%.

Back in 1980 the national debt was $800 bln and T-bill rates were 17%.

Today the national debt is $14 trillion and the rate the gov’t pays on T-bills is virtually zero!

THERE IS NO CORRELATION BETWEEN INTEREST RATES AND GOV’T DEBT FOR A COUNTRY THAT ISSUES ITS OWN CURRENCY AND WHERE ITS DEBTS ARE DENOMINATED IN THAT CURRENCY!

Bond yields are likely to continue falling as well. Japan’s debt is three times as large as the U.S. and the yield on 10-year Japanese government bonds is 1.5%. That’s probably where our 10-year is going.

Source: http://mikenormaneconomics.blogspot.com ... -lows.html

MMTers nailed that comparison to Japan. Rates went down after Japan was downgraded multiple times. MMTers understood why that happened and applied that knowledge the US...and they probably made a lot of money off of it.

Here's a good one from MMTer, Warren Mosler, dated July 23, 2011:

Consequences of debt ceiling extension outcomes
Posted by WARREN MOSLER on July 23rd, 2011

If Congress does get a bill to extend the debt ceiling to the President, he will sign it.
The US economy will continue to muddle through, with an extended soft spot and modest growth.

If Congress doesn’t get a bill to the President,
And if the US Treasury goes cold turkey to a balanced budget,
spending only as revenues accrue,
I forecast the following consequences:

Interest rates on US Treasury securities will fall, and not rise.

The US unemployment rate will move geometrically towards 100% until US Treasury deficit spending resumes.

Source: http://moslereconomics.com/2011/07/23/c ... -outcomes/

In general, MMTers didn't see how Treasury rates would rise when the government controls them so well.

Secondly, just the idea that the "trade" is crowded...and maybe a breakup of Eurozone is already priced in to the exchange rates.

At the moment, the market does not believe that the Euro will actually break up. So, that isn't "priced in". Most people believe that the problem will be kicked down the road for the foreseeable future. LTRO was a form of can-kicking introduced at the end of December. It didn't fix the problem, it just delayed it. The ECB can keep injecting liquidity into the system and kicking the can down the road for a few more months — maybe longer. That's the current game plan. It probably won't end very well.

MMTers point out that the only way to fix the fatal flaw in the Euro is for the Europeans to form a central Treasury (and government) to create true currency sovereignty. Europe needs to be a United States of Europe to have an American-style currency system that doesn't implode on itself.

From MMRer, Cullen Roche:

if the USA starts to decide not to pay interest on US Treasuries then bond markets will panic and yields will rise. That’s basically what we keep seeing in Europe. When the ECB says they’re not going to backstop the sovereigns the yields spike. It would be like California nearing default and the US government allowing the 8th largest economy in the world to default. That would be madness. The Federal government would write California a check just like they do every single year (just like they do for all 50 states). It’s not in the interest of our union to allow massive economies within the union to begin defaulting. After all, the states are part of the government. But Europe doesn’t have this unity. There is no political unity and no monetary unity in this regard. So you have Germany saying they don’t want to write the check. Okay, then kick the others out of your monetary union rather than holding them hostage in an unworkable currency system…..The USA made a commitment to sustain our monetary union through being a UNITED STATES OF AMERICA. Europe wants the benefits of a currency union without the political baggage that comes along with it. But that’s not how it works.
Source: http://pragcap.com/qa-the-answers-3

[Gumby]

...and if the MMT predictions on Treasuries weren't enough, MMTers nailed the fundamental flaws in the Euro years ago:

In 1992 Wynne Godley described the inherent flaw in the Euro:

“If a government does not have its own central bank on which it can draw cheques freely, its expenditures can be financed only by borrowing in the open market in competition with businesses, and this may prove excessively expensive or even impossible, particularly under conditions of extreme emergency….The danger then, is that the budgetary restraint to which governments are individually committed will impart a disinflationary bias that locks Europe as a whole into a depression it is powerless to lift.”?
Source: MMT, The Euro & The Greatest Prediction of the Last 20 Years

In his must read book “Understanding Modern Money”? Randall Wray described (in 1998) the same dynamic that led to the crisis in the EMU:

“Under the EMU, monetary policy is supposed to be divorced from fiscal policy, with a great degree of monetary policy independencein order to focus on the primary objective of price stability.  Fiscal policy, in turn will be tightly constrained by criteria which dictate maximum deficit to GDP and debt to deficit ratios.  Most importantly, as Goodhart recognizes, this will be the world’s first modern experiment on a wide scale that would attempt to break the link between a government and its currency.

…As currently designed, the EMU will have a central bank (the ECB) but it will not have any fiscal branch.  This would be much like a US which operated with a Fed, but with only individual state treasuries.  It will be as if each EMU member country were to attempt to operate fiscal policy in a foreign currency; deficit spending will require borrowing in that foreign currency according to the dictates of private markets.”?
Source: MMT, The Euro & The Greatest Prediction of the Last 20 Years

In 2002, Stephanie Kelton (then Stephanie Bell) was even more specific in describing the funding crisis that would inevitably ensue in the region:

“Countries that wish to compete for benchmark status, or to improve the terms on which they borrow, will have an incentive to reduce fiscal deficits or strive for budget surpluses. In countries where this becomes the overriding policy objective, we should not be surprised to find relatively little attention paid to the stabilization of output and employment. In contrast, countries that attempt to eschew the principles of “sound”? finance may find that they are unable to run large, counter-cyclical deficits, as lenders refuse to provide sufficient credit on desirable terms. Until something is done to enable member states to avert these financial constraints (e.g. political union and the establishment of a federal (EU) budget or the establishment of a new lending institution, designed to aid member states in pursuing a broad set of policy objectives), the prospects for stabilization in the Eurozone appear grim.”? (emphasis added)
Source: MMT, The Euro & The Greatest Prediction of the Last 20 Years

In 2001 Warren Mosler described the liquidity crisis that the Euro would lead to:

“Water freezes at 0 degrees C.  But very still water can be cooled well below that and stay liquid until a catalyst, such as a sudden breeze, causes it to instantly solidify.  Likewise, the conditions for a national liquidity crisis that will shut down the euro-12’s monetary system are firmly in place.  All that is required is an economic slowdown that threatens either tax revenues or the capital of the banking system.

A prosperous financial future belongs to those who respect the dynamics and are prepared for the day of reckoning.  History and logic dictate that the credit sensitive euro-12 national governments and banking system will be tested.  The market’s arrows will inflict an initially narrow liquidity crisis, which will immediately infect and rapidly arrest the entire euro payments system.  Only the inevitable, currently prohibited, direct intervention of the ECB will be capable of performing the resurrection, and from the ashes of that fallen flaming star an immortal sovereign currency will no doubt emerge.”?
Source: MMT, The Euro & The Greatest Prediction of the Last 20 Years

This really isn't about who has the bigger crystal ball. Many people have claimed the Euro was a bad idea over the years. MMTers and MMRers just figured out the operational realities early on.

Read more... MMT, The Euro & The Greatest Prediction of the Last 20 Years

[moda0306]

Gumby,

I find it interesting that part of the discussion revolves around whether or not some "deficit deal" is reached.... often referring to that deal as a GOOD thing for the economy.  I really think they have this call incredibly off.  The only thing keeping us afloat is deficits in excess of our current account deficit, making up for over a decade of NFA loss as a result of being a reserve-currency issuer afraid of deficit spending (though raw deficit amounts would imply otherwise).  We are literally "selling" our currency to foreigners, but actually holding that as a reason to REDUCE our deficit ("what if China stops buying our bonds") instead of increasing it to meet the monetary demands of foreigners.

If our military industrial complex built $300 billion in arms every year from the U.S., and our government sold $500 billion of our military arms to foreigners for consumables, would we gawk at that and say "our military size is getting out of control?" as our domestic military goes down every year?  Of course not... why?  Because we're selling (current account deficits) more than we're building (fiscal deficit).  It's perfectly natural for a country that can build tanks & guns well to export those things... just as it's natural for the worlds superpower to export its currency... however, we have to make sure we have enough for ourselves, too!

[moda0306]

Gumby,

Between your research skills and your patience with HTML, I would never want to online-debate you with the hopes of winning.

Probably not in person either.

That $hit is hauntngly amazing, IMO.  Warren Mosler for President (actually, I'm glad he re-tooled to go as a Dem in the senate.  Good tactical move, IMO).  I think MMT/MMR owes you a little bit of glory... you are bringing it to a lot of non-econonerds here.  That's precisely what needs to happen.

[Gumby]

Gumby,

Between your research skills and your patience with HTML, I would never want to online-debate you with the hopes of winning.

Probably not in person either.

I'm pretty terrible at debating in person. It's much easier to debate in HTML when you're just referencing and quoting others. But, I find it incredibly helpful to learn Google operators:

http://support.google.com/websearch/bin ... wer=136861

That way if you want to see what someone on pragcap.com or moslereconomics.com or gyroscopicinvesting.com had to say about something, you just use the site:somedomain.com operator to narrow your search to that site. It's way more efficient than using a site's own internal search engine.

That $hit is hauntngly amazing, IMO.  Warren Mosler for President (actually, I'm glad he re-tooled to go as a Dem in the senate.  Good tactical move, IMO).  I think MMT/MMR owes you a little bit of glory... you are bringing it to a lot of non-econonerds here.  That's precisely what needs to happen.

It's stunning. To be able to clearly and precisely diagnose a major currency problem so early on in its existence — years before the issues come to fruition — it's damn impressive.  The first few times I heard about MMT/MMR (which was about a year ago) I completely dismissed it. It took many weeks of reading and research for me to grasp it. Can you imagine trying to explain this to someone verbally? They would think you were crazy. I rarely tell people about it in person. Far easier to let people live in a gold-standard era delusion.