Jul

12

 Merkel does not see a banking crisis in Italy. She is waiting for Italy to intervene and save the banks with BAIL-IN and only after be able to save Deutsche bank with bail out. It would serve an avalanche for Deutsche bank …

Stefan Jovanovich writes:

Does anyone think that the world's central banks can "control" the relative prices of their national currencies? I don't; but I have the luxury of being completely ignorant about what and how GZ and others do in the trading of IOUs. I just see it as analogous to what the national Treasuries tried and failed to do with bi-metallism; no matter how much they huffed and puffed, they could never bring their official ratios for the prices of gold and silver into balance with what people bet they were worth.

If central banks cannot, in fact, "control" the exchange ratios of their own legal tender, they certainly can "control" the price of their domestic debts. No one doubts that the Fed or the Bank of Japan or the Bank of China or the Bank of England can determine what their national Treasuries will pay as interest on the country's central government's new borrowings and outstanding debt.

Can the European central bank prevent the Bank of Italy from funding whatever additional borrowings the Italian central government wants to make? Even those of us who are completely ignorant know that the answer is not going to be determined by "the law" but by the same politics that always govern essentially closed systems of interest. To put it in 18th century parliamentary terms, will the interests of the owners of the sugar islands and the city merchants who did their finance win out once again or will there be another tax revolt in the commons? So many people everywhere in Europe now get their money direct from the EU just as so many people in England got theirs from the Navy; but that is of no benefit to the people who are on the local government and private payrolls. They want their own payouts.

I confess I do not understand the notion of "peak" debt. The direct liabilities of the central governments are "high" but they are insignificant compared to the off-balance sheet promises that have been made for future retirement, medical and welfare payments. Governments can keep rolling over their debts and adding to them as long as they want; they have a zero interest credit card from their central banks. The only risk is that the professional scolds will (1) demand a "strict accounting" that brings those never-never plan obligations onto the country's official balance sheets AND (2) decide that the poor will have to go first in terms of "belt-tightening" (after all, they are all fat and should go on a diet).

Rocky Humbert responds:

Stefan's post reminds of Ben Graham's quote: "In the short run, the market is a voting machine, but in the long run, it is a weighing machine."

In the short run, the Bank of Italy, or any Central Bank or any Government or any enterprise for that matter, can do whatever they choose. In the long run, unsustainable policies are reflected in the exchange rate; or the cost of capital; or the access to capital; or in the wealth of a nation.

Right now, the ECB's policies have seemingly altered both the signals from markets and what defines "long run." I am not unique in making these observations of course.

My database shows that from May 1973 to September 1982, the Italian Lire declined from 800L/$ to about 2000L/$ — and it traded in a extremely wide band (+/- 50%) subsequently — until the conversion to the Euro. In the post-Gold Standard world, the Lire (and for that matter, most paper currency purchasing power) have always moved in one direction: down.

The current Euro regime is unprecedented in all of our lifetimes– it's creating all sorts of novel imbalances — both similar to and different from previous fixed exchange rate periods (which always resulted in violent or gentle devaluation). The biggest imbalance of all is being created by the ECB's QE buying of sovereign debt — which essentially allows the Bank of Italy to be immune from the discipline of the market. I don't know how this will resolve, but the Greek experience of the past years is one possibility.

The discussion about Scott's annuities are not unrelated. We have been in a protracted period of inflationary quiescence. When inflation and interest rates are low, people focus on "income income income." But when inflation is high, people focus on preserving their purchasing power. The most dangerous mistake any investor can make is taking for granted certain embedded truths — which turn out not to be a truth, but rather an assumption.


Comments

Name

Email

Website

Speak your mind

Archives

Resources & Links

Search