Why Is the Euro Still Gaining Against the Dollar?

09/12/2017Daniel Lacalle

The primary purposes of the incorrectly named “unconventional monetary policies” are to debase the currency, stoke inflation, and make exports more competitive. Printing money aims to solve structural imbalances by making currencies weaker.

In this race to zero in global currency wars, central banks today are “printing” more than $200 billion per month despite that the financial crisis passed a long time ago.

Currency wars are those that no one admits to waging, but everyone wants to fight in secret. The goal is to promote exports at the expense of trading partners.

Reality shows currency wars do not work, as imports become more expensive and other open economies become more competitive through technology. But central banks still like weak currencies — they help to avoid hard reform choices and create a transfer of wealth from savers to debtors.

The Euro Rallies

So how must the bureaucrats at the European Central Bank (ECB) feel when they see the euro rise against the U.S. dollar and all its main trading currencies by more than 12 percent in a year, despite all the talk about more easing? The ECB will keep buying 60 billion euro a month in bonds, maintain its zero interest-rate policy, and keep this “stimulus” as long as it takes, until inflation growth and GDP growth are stable.

Contrary to the wishes of the ECB, however, a strong euro is justified for several reasons. First, the European Union’s trade surplus is at record highs, and 75 percent of Eurozone trade happens between eurozone countries. Higher exports and the continued recovery of internal demand in European member countries strengthen the euro.

The third is the perception of weakness of the U.S. government and its inability to push through key reforms. This has weakened the dollar and by definition strengthened the other two large trading currencies, the euro and the Japanese yen.The second important factor is the relief rally after the French and Dutch elections. The fears of a euro breakup have been eliminated, or at least delayed, as pro-EU political parties won.

The Problems With a Strong Euro

However, a strong euro has very significant implications for the EU economy and the ECB’s policy.

The strong euro puts exports to its main outside trading partners — the United States (20.8 percent of exports in 2016) and China (9.7 percent) — at risk. Despite the ECB’s extreme monetary policy and a euro trading almost at parity with the dollar, exports to non-EU countries have stalled since 2013. GDP growth estimates for 2018 are falling due to a lower contribution of net exports.

The currency also has a high impact on tax revenues in Europe. The correlation between the euro–dollar exchange rate and the earnings estimates of the largest multinationals represented in the Stoxx Europe 600 Index is very high.

According to our estimates, a 10 percent rise of the euro against the dollar is equivalent to an 8 percent drop in earnings and leads to lower corporate tax revenues. From an investment perspective, as earnings drop, the European stock market goes from being relatively cheaper to becoming more expensive.

Investors and economists need to pay attention to these factors. If the euro continues to strengthen, the EU economic recovery is at risk. So the eurozone is stuck between a rock and a hard place. It cannot stop the stimulus because deficit spending governments cannot live with higher financing costs, and increasing the stimulus to weaken the currency simply doesn’t work anymore.

The only way out is structural reforms, but most governments are afraid of them even in good times, let alone when the going gets tough.

Originally published by Epoch Times. Reprinted with permission. 

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Why Did Ukraine Nationalize its Largest Private Bank?

07/09/2017John Mills

In December 2016, the National Bank of Ukraine (NBU) nationalized Ukraine’s largest private bank for what we now know was an incorrect understanding of the facts. It remains unclear who benefitted from this expropriation.

But it wasn’t just a misunderstanding. The nationalization of PrivatBank very likely was the result of a still-unexplained refusal by the NBU to accept the financial reality of the situation.

This extraordinary government takeover has made the banking and economic situation in Ukraine much worse rather than better, and is an almost classic case of government overreach.

The NBU’s inappropriate and unnecessary nationalization has hurt the Ukrainian economy, stolen millions from PrivatBank’s owners and is forcing Ukraine’s taxpayers to bear a substantial additional burden.

The NBU took its action in large part because of what it said was an unacceptable level of related-party loans: 90 percent or more was the number it frequently used.

But Ernst & Young, the global “Big Four” accounting firm the NBU hired to undertake an audit of PrivatBank at the end of 2016, said the actual level of related-party loans at PrivatBank was merely 4.7 percent.

And that very low level (an astounding almost 95 percent less than what the NBU used to justify its nationalization) is itself lower than the level of related-party loans reported a year earlier in a separate audit conducted by yet another Big Four firm: PWC.

Perhaps to protect itself from what will undoubtedly be withering criticism, the NBU is now considering suspending PWC from auditing Ukrainian banks, has accused one of the most renowned and highly esteemed auditors in the world of being “unprofessional,” and is at least hinting that its audits contributed to the situation.

The NBU has claimed that PrivatBank siphoned a majority of its equity to related party loans to enrich the bank’s shareholders. Operating activities show that the cash flow for 2016 was 21 billion Ukrainian hryvnia to client funds, but not to the issuance of loans to related parties.

Similarly, the NBU made an arbitrary, erroneous and harmful decision to regard PrivatBank’s collateral as unacceptable even though a significant amount of the loans that were classified as “impaired” should have been acceptable under IFRS standards.

But it’s not just the NBU’s decision to nationalize PrivatBank that’s questionable; serious issues have now been raised about the way the NBU carried out the nationalization once it decided to move forward.

The NBU’s capitalization of PrivatBank after the nationalization was a transfer of government bonds, rather than cash, that effectively was worthless.

Up to then, the NBU always required the valuation of collateral from independent appraisers so that its value would be recorded appropriately on the balance sheet. But, as E&Y stated in its 2016 audit report, ten days after the nationalization, there was a sudden increase of investments in government bonds that were never valued. Who will buy those bonds now?

But the biggest issue is why the NBU ever thought that government control through nationalization of Ukraine’s largest privately owned bank was appropriate in the first place. PrivatBank had a strong vote of confidence from its customers with 40 percent of the country’s private deposits and serving 44% of corporate clients. It had a strong positive track record of supporting Ukraine’s economy and creating jobs. And, as a report by E&Y (the auditors chosen by the NBU) subsequently confirmed, according to IFRS standards its financials were far stronger than the NBU was charging.

All of this makes the NBU’s nationalization of PrivatBank more of an unnecessary expropriation – a taking by the government – than a good banking practice. That is the textbook definition of a scandal.

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What Keeps James Bullard Up at Night

05/26/2017C.Jay Engel

I hate to be the bearer of bad news before a three day weekend, but St. Louis Fed President James Bullard informs us that "U.S. prices are now 4.6 percent below the price level path established from 1995 to 2012, when inflation was growing near the Fed's target of 2 percent each year."

This lower than expected price level is deeply "worrisome," for Bullard. 

The delight that the average main-streeter feels upon observation of a store sale, or the general falling of the price of all kinds of electronic devices, is not an emotion shared by our well-educated bureaucrat monetary overlords. Instead, evidence of prices falling below their price level path expectations, is of serious concern.

Now, given the above tragedy, it appears to Bullard that the Fed's rate hike expectations are "overly aggressive." That is, in order to save the United States from the haunting specter of falling costs of living, the Fed may need to remain "accommodative," ever ready to flood more debt into the system. How original.

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Will the IMF Bail Out Greece Again?

04/24/2017C.Jay Engel

Greece is on the hook for a €7 billion debt repayment in July, but may not be prepared to meet the obligation. If Europe doesn't agree to come to an alternative agreement, the IMF may step in and bail them out again. This, according to the New York Times, which writes:

As the International Monetary Fund approaches the seventh anniversary of the contentious Greek bailout, it is torn over whether to commit new loans to a nearly bankrupt Greece.

The fund has been criticized for overcommitting financial resources to the European debt crisis.

Yet the I.M.F. has an obligation to lend to countries that are in financial need as well as to safeguard global financial stability.

Ostensibly, the role of the IMF is to safeguard global financial stability and it therefore would rather continue to throw money into the black hole of Greece than let it default. What this amounts to economically is a grand case of wealthier governments propping up overly indebted poorer countries against any standard of financial prudence. And since no government acquires its wealth in the first place, the IMF acts as a mechanism of wealth transfer. As the New York Times observes:

For example, the €30 billion the fund lent to Greece in 2010 was 30 times more than the sum of Greece’s financial contribution to the fund as a member, which is called a quota. The loan is one of the largest in the history of the fund, which was formed in 1944.

Of course, this money above and beyond Greece's own "quota" came from the taxpayers of other countries, who don't get any benefit at all out of the IMF's wealth transfer scam. As we near Greece's repayment date, we are going to get nothing from the press about the Western taxpayers on the hook for the Greece bailout — and neither are we going to hear anything about the creation of debt by central banks which makes these debt crises a reality in the first place. Instead, we are going to get a surface debate about whether Europe or the IMF should compromise over Greece's dire and never ending problem.

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Why the "Experts" Can't Agree About Fed Rate Hikes

02/20/2017C.Jay Engel

It's amazing how the same set of economic data can create two very different opinions on the overrated Fed Funds hike issue. In two Bloomberg opinion pieces last week, we see the stark difference:

Tim Duy: It's Way Too Early for the Fed to Consider a March Rate Increase

Charles Lieberman: The Fed is Behind the Curve

To make their cases, both cite the employment numbers and the consumer price inflation rate. Duy states that the Fed wanted the unemployment rate to be around 4.5 percent, but it's still at 4.8 percent. So allegedly, it's got "room to run." Lieberman looks at the unemployment on a broader timeframe and concludes that the current levels have "historically been universally regarded as full employment."

On price inflation, here is Duy: "Core inflation, as measured by the Fed’s preferred price index, was running at just 1 percent on an annualized basis in the final three months of 2016."

And then Lieberman states that price inflation is already above 2 percent "for all the primary inflation measures, except the Fed’s preferred measure, the core personal consumption deflator, which may also soon rise above 2 percent."

In other words, statistics are not standalone, self-interpreting declarations of the nature of reality. Rather, they are highly interpretable and theory-dependent, in sharp contrast to the positivism of modern economics. The Fed and economic commentators are blinded and stuck in perpetual contradiction with each other. The solution is not better statistics or "more clear data," which the Fed seems to have been dependent on for the last 8 years since the crisis. The solution is better theory, an entire new framework. Without theory, statistics are useless.

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Will this Finally Be the Year the Fed Cuts its Balance Sheet?

01/31/2017C.Jay Engel

Now that the Fed has slightly upped its Fed Funds rate target twice, there is talk of a much more ominous issue: shrinking the balance sheet. Late last year, St. Louis Fed president James Bullard affirmed that 2017 “possibly might be a good time to play that card.”

What that would entail, of course, is reversing the years of a ballooning balance sheet by selling the securities that it previously attained. In selling assets, the Fed sops up bank reserves and they can no longer be used in the economy.

The entire economy — as well as the so-called recovery — since the Fed began it’s unprecedented asset purchase has been a giant mirage. It rests on the band-aid of financial moves from the Fed that papers over the reality of the situation. The problem with band-aids (monetary expansion) in our context is that no one notices the rot underneath (the destruction of real capital).

If the band-aid is ripped off, the underlying reality is exposed. There is some worry that “the market” will respond poorly. Indeed! Why? Because the whole reason that “the market” has achieved new heights over the years is because it knew the Fed was there to backstop losses and buy assets! Reversing this trend doesn’t create a new crisis, it allows — finally — the healthy correction to complete itself.

It is for this reason that the Fed and the Official Economists want to delay this as long as possible. Hence, in his most recent post, Ben Bernanke urges extreme “patience” [sic for “I hope we never have to do this”] in addressing the size of the balance sheet.

Bernanke had “indicated in testimony in 2013 that the FOMC was considering slowing asset purchases” and this resulted in the so-called “taper tantrum” in which the financial markets roared in disapproval. As Bernanke recalls, “FOMC members pushed back” against the idea that all this talk meant rates were going to rise. In other words, the market threw a fit at the possibility to lessen cheap money and the FOMC rushed in to promise open spigots.

With all the talk in Fed circles of “avoiding [market] disruptions” in the fake quest to shrink the balance sheet it appears to be a brewing financial theme without much substance. Just as the Fed undertook a 7 year narrative of raising the Fed Funds rate, it may take the entire Trump era to “talk about” shrinking the balance sheet.

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