Monday, April 18, 2011

America and Europe go to war


Babylon's Burning © The Times

News comments:
As Harry Hill would say, "Which is better? The USD or the EUR? There is only one way to find out ...fight!" (youtube)

Post IMF bail out of the UK in the late 1970s, the UK endured some inflation, unemployment and social unrest. Today we are too civilized to entertain such nonsense, but it appears the current market manipulation tussle between the Fed in the blue corner and the ECB in the red corner is just about to hot up and instead of civil war we will soon be facing a real war.

The Fed has been keeping short term rates low to stimulate its economy. It is also selling huge default insurance on its long term debt in an attempt to get long term yields down. The cynical Ben Bernanke has been buying up the long term debt and replacing it with low rate junk (ftalphaville). Of course, the biggest threat to this hedging trade on the US balance sheet is inflation and credit ratings.

America is the world's reserve currency so it has a nice Triple A. Well, unusually for an American owned Credit Rating Agency (CRA), Standard & Poor has decided to put the USA onto negative watch. (bloomberg). Reasons given are TOO MUCH DEBT AND ITS A CREDIT RISK.

So this means their is a chance of default risk. But not to worry because the US can just buy more debt and print more money. For the time being.

Now inflation is picking up. All over the place, input and output prices are rising and a dose of interest rates should bring it down again. It will also strengthen the USD and make imports from inflation ridden China cheaper too.

But the Fed is more obsessed about saving the banking sector. Inflation is for the poor to worry about it. Bernanke wants to keep US debt yields nice and low and with its put option deluge it is doing a great job. The threat of this going horribly wrong is when inflation really starts kicking in and its currency going into free fall.

The politicians want rates to be low to keep the servicing and financing of their debts low too. The recent budget fights have all assumed low rates of interest and this seems reasonable because the USA is artificially keeping rates down so it can issue cheap long term debt to fund long term projects. (latimes). But what if nobody wanted the debt at current yields?

This is the beginning of the end of the USD being the world's favorite currency. (fintag)

The CRA's have been pounding the likes of Ireland, Greece and Portugal which is odd because its debt is tiny in relative and absolute terms against the USA. Europe is dysfunctional the way America is. America may have states but Europe has countries. California is like Greece;

However, Europe which has the same inflation rate as the USA has decided interest rates have to rise. When rates rise, hot money comes in and where does it come from? Holders of the USD.

So the ECB is going to kill the USD by hiking rates (bloomberg). The USA will be facing further declines, more inflation and higher long term yields before it will have to put up short term rates. If Bernanke keeps his stubborn hat on, the USD will just keep on declining and places like China will keep on selling.

So who will win?

The USD has won the first few rounds but there is a large gash over its left eye. Left and red and opaque to the EUR which has taking some steroids without the USD noticing.

Today's shorts:
Brits abandon Europe because it is too expensive (telegraph)

Today's longs:
Greeks to go on strike (reuters)

Chinese to have a piece of Citi (reuters)

Bernanke is the love child of Bernie Madoff.