I have always wanted to be at the sort of gathering where such a thing could be said with a straight face. It reminded one of the good old days. That the dinner was with Paul Volcker [former Fed chairman] only heightened the sense of nostalgia.
The expectations of a Watford fan…
Markets remain hostage to news flow from Europe and today’s EU summit is the next focal point. There is something strangely reassuring about waiting for European leaders to announce concrete plans to shore up the foundations of the single currency. It’s a bit like being a sports fan at the beginning of the season when all outcomes are possible and one imagines great things. Those of us who support Watford Football Club have even seen occasional great things. But most of the time, one is merely reminded of the limits of human endeavour.
The good news is that there is a growing realisation among European politicians that the only credible way to put the euro area on a sustainable path is a move toward fiscal union. It may be that a statement of intent at the meeting may be enough to give markets support to the year end.
It would also allow the European Central Bank to continue to buy peripheral European bonds via its Securities Market Programme (SMP). It may even allow the ECB to increase its activity, which would again be supportive in the near term.
The moves by six developed world central banks on 30 November to cut the price of dollar liquidity funding was also good news in the sense that it was a reminder that co-ordinated action by central banks is possible. Although this is in itself a measure aimed at the plumbing of the system rather than any easing of policy, the positive impact on investor sentiment was noteworthy.
Given that it occurred, coincidentally or not, on the same day that China eased its required reserve ratio for all banks to 21% from 21.5%, added to the sense that the worst case scenario of policymakers sitting idly while chaos erupted was unlikely to happen.
These recent actions followed the Bank of England embarking on QE2; the Federal Reserve focusing buying on the long-end of the US Treasury market in Operation Twist; the Swiss National Bank tying the franc to the euro and the ECB cutting rates last month. As we stated before, one should be wary of fighting the Fed and its friends.
Balanced and cautious
So betting on Armageddon isn’t advisable. Rather, a balanced approach is necessary. But that balance still has a cautious tilt because behind the various actions undertaken recently, and those likely to be taken over the balance of this month, are some pretty fundamentally bearish things.
The world continues to have the structural challenge of deleveraging by financial, household and government sectors at a time when cyclical weakness is increasingly evident. This is most pronounced in Europe but is not unique to Europe. We see the euro area crisis as a symptom of the broader problem.
But within Europe the challenge is great because the solution requires such a dramatic jump towards a European government. The only solution that will have any lasting chance of success is a move toward common issuance backed by fiscal union. As part of that process, the ECB would have to become like the Bank of England and the Federal Reserve, a fully owned subsidiary of a government, presumably a European government. So, the apparently sensible and innocuous idea that there should be a commonly issued eurozone bond actually requires that there be a eurozone sovereign government that presumably is senior to individual nation states.
Would the same European financial market practitioners, who are braying for common issuance themselves, vote in a referendum for subordinating their nation states to a eurozone government? My guess is that the answer is “No” which means there will have to be an attempt made to change Treaties that would allow common issuance without the need for holding popular votes on the subject.
This may well be possible. After all, the whole European project has never been blessed with mass democratic support. But it will take time.
