Capital Markets Update

By Louis S. Barnes                             Friday, September 7th, 2012


First, an expression of gratitude. Reality — new economic data and active central banks — has removed any duty to pay attention to the convention of either party. August job data released today were poor. The meager 96,000-job gain was cut in half by downward revisions to the two prior months, and the apparent decline in unemployment from 8.3% to 8.1% is a statistical quirk — the percentage of Americans at work and trying to find it fell to the lowest level since 1981.
There is no way to fund necessary government on a tax base so weak. Democrats are focused on grabbing larger pieces of a shrinking pie, and Republicans on helping those with pie to keep it, when the perfectly obvious task at hand is to grow the pie.
As poor as the job data were, other reports describe a minor miracle: the US is not entering recession. ISM August manufacturing slid further to marginal negative, 49.6 (from 49.8), under pressure from a slowing external world, but the ISM service sector surprised on the upside, to 53.7 (from 52.6).
Consensus this morning has this data weak enough for the Fed to announce another round of QE on September 13, perhaps focused on MBS. The prospect of more easing has had the stock market on the manic side of its bi-polar disorder, but flipping to depression when considering the reason for the easing: the economy is a mess, and new QE is not guaranteed to work.
All of the above is a brief interruption in the European drama. Yesterday the ECB announced its new plan to prevent collapse of the euro, ECB president Draghi once again huffing, “The euro is irreversible.” Of course it’s reversible — if it were not, Draghi would not have to say. And on another level, many senior officials in Europe seem to be posturing to avoid blame for the ultimate collapse. In Europe’s history, leaders who have caused this degree of pain have met an end dangling from a lamp post.
The ECB labored long and hard to gain approval for the new plan, Outright Monetary Transactions (“OMT”), but in the end the elephant gave birth to a mouse.
There are several available paths to euro collapse. Banks were on the way out last fall, and the ECB stopped that with the LTRO (one trillion euros in loans to banks). Another would be the inability of Spain and Italy to roll over their sovereign debt, hopelessly excessive relative to their GDPs. Those markets closed this spring, temporarily propped open by their domestic banks and legerdemain.
OMT mightily proposes to buy unlimited amounts of sovereign debt with invented money. However, the ECB will execute the OMT buys if and only if miscreant nations agree to the Greece treatment, surrendering control of their budgets to more austerity and ensuring deeper depression. And oh-by-the-way, for every euro we create to buy these bad bonds, we will sell another euro-worth of a different IOU in our vault, leaving the net cash injection into the European economy at zero.
This process is called a “sterilized” trade, unlike QE here in which the Fed tries to force-feed cash into an already-sloshed goose, but at least is trying. One extreme measure the ECB might adopt: un-sterilized OMT buys, which would crater the value of the euro and give weak economies a fighting chance via exports. Unfortunately that approach would create inflation in Germany and destabilize European trading partners.
If Spain or Italy does grovel to the ECB, or does the honorable thing, accepting the ECB’s terms while lying about compliance, only one benefit to their economies will result. Each percentage point knocked off their borrowing costs will be roughly one point of GDP less in spending cuts that will be forced by the ECB Gestapo. Big deal. Their economies cannot survive the cuts underway now. Not while bolted to the euro.
My cynicism may be too deep, as always, but OMT has done nothing but protect Draghi from post mortem accusations of hand-sitting, and the political structures in Spain and Italy (and soon, France) are under the same pressure as before.
Bill Clinton’s Law, dating to 1993, seems more elusive today than ever, even to the old rogue himself. “It’s the economy, stupid!” Grow the damned pie, or else.