Geithner and the delicacy of Euro-Dollar diplomacy
The departure of US Treasury Secretary Timothy Geithner to Europe to rescue our allies from themselves marks a change in the economic relations among the NATO countries that bears scrutiny. In the past, the loosely-connected federation we call the European Union has managed to muddle along. But now we see overt funding subsidies for the EU via the Fed and the active involvement of Geithner in what ought to be a purely domestic fiscal discussion.
I suppose that kudos are in order for Geithner and Fed Chairman Ben Bernanke for finally responding to the EU funding crisis. Bernanke has been sound asleep at the liquidity nipple, not realizing it seems that the Fed supervisory personnel were instructing US institutions to sever credit lines with their EU counterparts. Since most of these banks are now effectively nationalized, the behavior of US regulators in New York seems especially self-injurious. Now we have replaced private funding for EU banks with central bank swap lines. Hoo-rah. This is not so much a rescue as it is a temporary subsidy.
Geithner has his work cut out for him. Having worked in the Federal Reserve Bank of New York in the currency area during the Plaza Accord, this author has some ideas on the financial and psychological efficacy of central bank intervention. The key thing for any central bank trading desk is not to pretend that you are the market, but instead to support market activity and to slowly help restore the flow of private credit in the markets. Unfortunately this lesson still seems lost on central bankers on both sides of the Atlantic.
My friend Achim Dübel of Finpolconsult in Berlin, is critical of the handling of the intervention by the European Central Bank. Referring to a recent research note by Goldman Sachs on the outlook for the EU, he asks:
Does GS have on its radar how distortive and damaging are the ECB interventions into periphery debt at 80 or 90 cents? The ECB bought Greek debt at those levels a year ago – average portfolio cost is estimated at 70-80 cents, where market prices are now 30 cents. Why are market prices now at 30 cents? Because the ECB had to stop buying. After looking into the abyss of Greek default, the ECB simply ran away.
In the case of Greece and now Italy, Dübel notes very aptly, the ECB has been buying bonds well above the true market. “Now they are doing the same with Italian debt as they did with Greece, and of course the ECB will run away again,” Dübel adds. “With the banks the intervention levels were far too high (haircuts too low), with the worst example of all being Ireland. In all these cases, ECB became an obstructionist force against restructuring, i.e. solving the problem.”
Now, it seems, we know why Axel Weber, the ECB’s German board member, resigned from the board in protest last year. Geithner needs to quickly figure out whether the core EU nations can begin to act in a more rational and purposeful way when attacking issues of solvency, both of banks and nations.
Lagarde recently warned that the egos of world leaders are putting the global economy at risk. This is a nice way of saying that none of the leaders of the G-20, elected or not, are in the mood to take the risk themselves of publicly confessing to the true scale of the problem of excess debt and shrinking demand facing each nation. But as Geithner goes to the EU to preach tough love to his European counterparts, he leaves a lot of unfinished business at home.
Geithner ignored President Barack Obama’s order to consider dissolving Citigroup, a new book by Pulitzer Prize-winning author Ron Suskind claims. The top four banks in the US remain on the critical list, even with bulging deposits and capital levels. So when Geithner lectures his EU peers on the need for prompt and purposeful action, he will need to season his advice with humility and an appreciation that the war against global deflation is far from won.