Monday, May 14, 2012

More Thoughts on BNY Mellon Presentation

Scanning the headlines today, I reflected again on Simon Derrick's presentation in Minneapolis last week. He did suggest that "weasel words" would increasingly populate official statements from European prime ministers and Euroland officials.  The Bundesbank's Chief Economist started the trend, when the WSJ reported "...days after the Bundesbank's chief economist, in testimony to the German Parliament, said German inflation could be higher than the euro-zone average for a time if the country takes steps to boost its service sector and raise investment while Greece and others slash wages and government spending."

The Bundesbank's President Jens Weidmann quickly blustered about the bank's resolve in fighting inflation, but at the same time he alluded to a word, "rebalancing," which seemed to allow the possibility of higher EU inflation rates if the periphery countries made adjustments.  From this, other stories appeared about Chancellor Merkel's being willing to accept the fact that the ECB would have to lead a European triage effort by printing trillions of Euros. 

None of this seems at all probable.  The German electorate is already beginning to turn against the ruling coalition led by Chancellor Merkel.  German banks and businesses, particularly the exporters, would not be happy thinking about the electoral alternatives to the current coalition. 

For over two years, we've explained why we think that the euro was doomed in its current construction.  A weak zone and strong zone European union would be inefficient, ineffective and politically unpalatable all around.  We mentioned Simon Derrick's comment about adopting the euro devastated the economies of Ireland, Spain and other peripheral members.  He also mentioned a true tail risk, something which on the face of it seems impossible.  What if Germany left the euro?  

German interests are not served by any of the possibilities currently being discussed, so the more likely solution is that Chancellor Merkel picks the least repugnant, sub-optimal choice from a bad menu.  However, leaving the euro itself and letting everyone else sort it out is worth thinking through. 

Incidentally, as bad as the prospective returns are for U.S. Treasuries, they may again serve as short-term haven for European assets as they continue to flow out of European banks and investments looking for a better home.

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