The Great Debate

from James Saft:

Waiting for Europe’s QE to sail

The good news is that the European Central Bank will probably start a massive additional round of quantitative easing to fight the break-up of the euro zone.

The bad news is that they will, as ever, only choose the right policy, as Winston Churchill said of the Americans, after exhausting all of the alternatives.

Global share markets rallied furiously on Wednesday, fed by hopes that the ECB would increase its bond-buying efforts, a possibility raised by its chief Jean-Claude Trichet in an appearance before the European Parliament. Trichet faces stern opposition inside the ECB from fellow central bankers, notably German Axel Weber, who believe that policy should be normalized rather than loosened.

This opposition, in combination with an unsure political climate, means that euro zone authorities will probably continue to try to buttress, enlarge and formalize the bailout mechanism while trying to maintain the fiction that something approaching normality reigns in European money and bank funding markets.

Why would QE be used to fight the break-up of the euro zone, now being widely discussed as the crisis spreads to ever larger member states?

Beware China gunning for speculators

James Saft is a Reuters columnist. The opinions expressed are his own.

There is a pretty good rule of thumb in global financial markets: if you want to know where problems are beyond the reach of policy, look for places where the authorities are blaming “speculators”.

So it was in Europe, where last spring, as the depths of the euro zone’s problems were becoming clear, officials railed at the speculators who had the temerity to point out the obvious: that several nations would not have the money to repay their debts.

Greece and Spain went so far as to put their intelligence agencies on the case of tracking down speculative “attacks.”
So, it would seem, is it now in China, with food prices.

QE2 to speed triumph of emerging markets

While “decoupled” is not the same as “immune”, look for growth and investment performance in emerging markets to be better than in the sclerotic developed world.

In the short term emerging markets will be free riders as the U.S. launches the second round of quantitative easing. A portion of the stimulus generated by “QE2″ will inevitably leak cross border, while the risks of the gambit will fall almost entirely on the U.S. and on dollar-denominated assets.

QE2 is designed to work in two ways: to stimulate investment by making it cheaper to borrow money and to lift consumption by boosting asset prices.

Fed is banking on phony wealth effect

The Federal Reserve is committed to enticing Americans into doing once again what worked out so badly in the last decade: spending the phony paper gains engineered by overly loose monetary policy.

That, at least, is the very strong impression given by a speech by Brian Sack, the markets chief of the New York Federal Reserve, a man whose job it will be to implement the second round of large-scale quantitative easing coming after the elections in November.

A round of speeches from key Fed officials has given the clear view that, faced with deteriorating conditions and trapped by the lower bound of zero in its monetary policy, the Fed is preparing to once again buy up large amounts of Treasuries, perhaps even more than the government is issuing on an ongoing basis, in an attempt to drive down market interest rates and stimulate the economy.

China runs circles round adversaries

If the global currency war was a baseball game, they would have to invoke the “slaughter rule” and send China home the winner.

Motivations and consequences aside, China is so adroit in melding diplomacy, jawboning and action to keep the value of its currency low that you have to feel something approaching compassion for its plodding adversaries from the U.S., Europe and Japan.

China’s latest well played move is its pledge to use some of its massive foreign currency reserves to support poor Greece, which the markets widely believe will default some fine day, European Union support or not.

Speculators and China win big on yen move

What does $4 trillion a day in business, never sleeps and sees Japan’s Ministry of Finance as just one more patsy?

The foreign exchange market, of course, which is licking its collective lips as Japan embarks on another round of unilateral intervention to sell the yen in an effort to drive down its value and protect its export-oriented economy.

There are going to be two big winners in this, and neither begins with a “J.”

Irish plight about more than austerity

Ireland and its economic unraveling is not simply a test case of the stimulus versus austerity dispute, it is an illustration of the limits and pitfalls of the very popular strategy of keeping the banks ticking over, hiding under a desk and hoping for a strong recovery.

Previously praised for taking a tough fiscal stance which fans hoped would put it on a solid footing, Ireland now seems more vulnerable than ever. Concerns that the costs of the banking bailout will exceed the government’s ability to pay, even with European Union support, have battered Irish debt in financial markets.

The price of insuring Irish government debt against default hit a record on Wednesday, with markets extracting a premium of just over 4 percent of the amount being insured. Similarly the yield investors demand to hold 10-year Irish government bonds has increased greatly, hovering just around 6 percent, or 380 basis points more than German benchmark bonds.

Housing double-dip threatens banks

Another dip in U.S. housing looks likely, bringing with it difficulties for banks and for their government guarantors.

What is perhaps worse: having chucked money at supporting asset markets in order to support banks the past two years, the policy options for handling another housing downturn and banking crisis would be greatly circumscribed.

If you think the debate about more fiscal stimulus is heated, wait until you see the venom which the prospect of another housing and banking bailout brings.

The Knightian dog ate my recovery

Remember when business and economic leaders droned on about “100-year storms,” 2008′s get-out-of-jail free card for people who missed the housing bubble?

This was the whole idea that there was no way that people could be held accountable for the crisis because the notion of there being a problem with continual double-digit house price growth and sky-high leverage was just so darned unlikely.

Well, it looks like we have the 2010 version of how the dog ate their homework again and this time it is called “Knightian uncertainty.”

UK houses, Occam’s razor and fraud

We may just possibly have an explanation for how British property prices have held up so well though the crisis: fraud.

One of the puzzles of the past year is the way in which British house prices have managed to recover in value despite still being extremely expensive relative to both British earnings and historical precedent. While house prices are down a bit more than 15 percent since their peak, on the Halifax measure, they have actually risen 6.3 percent in the past year, not the best vintage in British economic history.

Even more astounding, a British house now costs 4.76 times average earnings, down from the silly 5.85 times in early 2007 but still 20 percent above a historical average which itself is inflated by two bubble periods. How, you must wonder, do these people afford those houses?