Sunday, September 19, 2010

European debt, currencies and gold

Blogging on ftalphaville, El-Erian echoes my take on currency intervention and gold, against the backdrop of debt concerns:

Guest post: El-Erian on an interesting week ahead

Mohamed El-Erian, chief executive and co-chief investment officer at PIMCO, argues that this week will show Europe’s debt crisis and the global configuration of currencies returning to the fore.
This coming week will be an interesting one. I am not just thinking of Tuesday’s FOMC meeting in Washington that will shed light on whether the Federal Reserve revises down its economic growth projections (it should and, I suspect, will) and expands non-conventional policies (it will, but probably not at this meeting).
I am also thinking of two other issues which were left to simmer quietly over the last few months when most of the focus was on America’s “recovery summer” — or, to be more exact, the lack thereof.
The first pertains to Europe. Solvency concerns are again on the rise there.
Last week’s catalyst was Ireland where banking issues are a serious worry. But the underlying problems are deeper and more complex.
Market measures of risk for peripheral European countries (Greece, Ireland, Portugal and Spain) are at or near danger levels… despite exceptional support from the ECB, EU and IMF, and despite the implementation of adjustment measures on the part of some.
The failure to reduce risk spreads means that the public sector bailout is not working. Rather than provide assurances of better times ahead and, thus, encourage new investments, ECB/EU/IMF support funding is being used by existing investors to exit their exposures to the most vulnerable peripheral European countries.
This situation cannot be sustained forever. It undermines any chance that the most vulnerable countries (e.g., Greece) have of limiting the collapse in their GDP and maintaining social cohesion; it contaminates the balance sheet of the ECB; it exposes the revolving nature of IMF resources to considerable risk; and it raises the risk of renewed contagion.
The second issue is even more complex. It pertains to the global configuration of currencies.
Last week, Japan intervened massively to stop its currency from appreciating. It did so in a unilateral fashion and, immediately, faced criticisms from Europe and the US.
Meanwhile, in a sharply-worded testimony to Congress, Treasury Secretary Geithner provided lots of data to those that feel that the US should have already labeled China a currency manipulator. And while China has recently accelerated the rate of its managed appreciation — 1% in the last week compared to just 1.6% since the country declared great “flexibility” back in June — this is proving insufficient to counter growing currency tensions.
These latest foreign exchange developments bring to the fore an inconvenient reality. While not all industrial countries wish to make it explicit, they are happy (indeed eager) to see their currencies depreciate. They see this as helping them address the extremely difficult challenges associated with a protracted period of low growth, high unemployment, and limited policy effectiveness.
The list of industrial countries wishing to depreciate their currencies is not matched by a list of emerging economies happy to let their currencies appreciate significantly. As a result, foreign exchange tensions are mounting, and the price of gold has been driven to a new record level.
This week will shed light on whether policymakers can do anything to deal with these two issues. If they continue to stumble and hesitate, what has been simmering may well come to a full boil in the next few months.

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