EUR

Wrong thread, but the UK austerity budget is crazy in my humble opinion.

Dollar Gains Buckle as Strategists Draw Line at $1.20

We are scary, scary owners of euros, said Taylor, whose firm manages $7.5 billion. We are keeping our fingers crossed that maybe the euros appreciation lasts through July and into August. But then the euro is just going to get crushed as its an impossible situation in Europe.
http://www.bloomberg.com/news/2010-06-27/dollar-s-biggest-rally-since-91-buckles-as-strategists-draw-line-at-1-20.html

Romania the new disaster master, its currency touching new lows.

Where is every body today? It's awfully quite here today.........

The risks of fiscal austerity

Unfortunately, the answer to the fiscal austerity question isnt black and white. There is no question that countries cannot run these kinds of enormous deficits without getting into trouble. Deficit hawks point to the Britain under Margaret Thatcher and the benefits of that painful restructuring.

While the Thatcher experience is instructive, there is a differences between then and now. Thatchers Britain was the only country in the region to take the deficit reduction path at the time. It worked because of my favorite economist phrase everything else being equal. What happens everything else wasnt equal and if everyone tries austerity at the same time? Martin Wolf of the FT explains [emphasis added]:

[S]uch thrift entails either current account surpluses or fiscal deficits. Of these countries, only Germany and Japan have current account surpluses. The rest are capital importers. These countries will duly run fiscal deficits that are bigger than their private surpluses. We have, as the hysterics note, a tide of fiscal red ink. Which came first private retrenchment or fiscal deficits? The answer is: the former. In the case of the US, the huge shift in the private balance between the fourth quarter of 2007 and the second quarter of 2009, from a deficit of 2.2 per cent of GDP to a surplus of 6.6 per cent, coincided with the financial crisis. The fact that aggregate demand and long-term interest rates tumbled at the same time shows that the collapse in private spending crowded in the fiscal deficits. Wild private behaviour drove the wild public behaviour.

Yet it would now be particularly damaging for fiscal austerity to overcome the European economy and so force beggar-my-neighbour outcomes on the hapless US. As Fred Bergsten of the Peterson Institute for International Economics in Washington noted in the FT last week, such policies could be very dangerous. Thus, far from being stabilising, premature fiscal retrenchment threatens destabilisation of the world economy. In this case, a decision to turn the eurozone into a huge Germany would and should be seen as an act of mercantilist warfare upon the US. How long would the latter put up with the hypocrisy of surplus countries that blame borrowers for the deficits their own surpluses make inevitable? Not much longer, would be my guess, at least now that the US government has become the worlds borrower of last resort.to be a balance.

New Keynesians like Paul Krugman believe that its far too early for austerity and such policies would be disastrous for the world economy. Indeed, it may be somewhat early to implement austerity programs. In their book This Time is Different, economists Reinhart and Rogoff studied a range of financial crises throughout history and observed that government debt rises an average of 86% after a banking crisis.

The US states as fiscal laboratories
Consider what would happen if that kind of budget cutting were to occur in the US. We have a laboratory in America: the states, which are required to be balance their budgets. The New York Times reports that individual states are starting to look like Greece. Time has written on the dire state of the states. California is on the verge of system failure and that experience is not isolated. Barry Ritholz pointed out that much of the state budget woes stem from unemployment. State budget austerity is therefore pro-cyclical, which would exacerbate the problem.

What about the muni market?
This is a recipe for disaster in the financial markets. The muni market seems to be oblivious to the coming storm. Minyanville recently reported that investors are flying to municipal bonds like moths to a flame. I agree with Rick Bookstaber that the municipal bond market is an accident waiting to happen.

What happens then? TARP for state and local governments? What happens to sovereign debt risk then?

Remember the adage that all politics are local and populist sentiment is sure to rise under such circumstances. The Globe and Mail quoted Warren Buffett as believing that bailouts are inevitable:

Billionaire Warren Buffett, who advised U.S. President Barack Obama during his White House run, suggested recently that a Washington bailout of California and other troubled states is inevitable. How, he wondered, can Washington deny California after saying yes to General Motors, AIG and dozens of banks.

Do we want to really want to see the US government pile on with fiscal austerity at the federal level?

With No New News, EUR/USD Just Seems To Be Following Stocks

Not going anywhere fast at the moment. EUR/USD sits at 1.2375, exactly where it was about 4 hours ago, going nowhere fast at the start of the new week. The pairing just seems to be following the gyrations of European stocks which are back in positive territory as I type this.

Sell orders noted up at 1.2400, stops through 1.2340. Maybe 1.2340-1.2400 can hold things until North America gets in and I can go fishing.

Cable sits at 1.5055, pretty much where it closed out Friday in North America. There is talk in the market that a UK clearer needs to buy cable today for dividend payment purposes. Effect is not thought likely to be overly large, but may well be helping underpin the pairing in recent trade.

For Those With Interest In AUD/USD, Just a Reading

Dow Jones piece. Westpac recommending selling AUD/USD in high .8700s/low. 8800s region, represents good risk reward at start of Q3.

Downside target .8400, stop just above .8900, which covers 61.8% retracement level of the high .9300 to .8000 downside move.

Westpac say market is not recognising the potential for a further slowing in Chinese data momentum over the next month.



No easy choices - Hurt now or hurt later?
I wrote before about an analytical framework for the deficit hawks. Economists at the BIS recently wrote a report the likely trajectory of government spending and the kind of reductions and actions that are required to bring deficits under control.

The Centre for Economic Policy Research recently released a discussion piece on the deficit reduction question and put the dilemma into perspective. The Economist recently had an article that explained the deficit conundrum more simply:

Debt is as powerful a drug as alcohol and nicotine. In boom times Western consumers used it to enhance their lifestyles, companies borrowed to expand their businesses and investors employed debt to enhance their returns. For as long as the boom lasted, Mr Micawbers famous injunction appeared to be wrong: when annual expenditure exceeded income, the result was happiness, not misery.

Now comes the hangover. Its a question of whether we want to hurt now or hurt later. There are no good choices. This is only a slight exaggeration but politicians who choose an effective hurt now option, as per the BIS analysis, could go down in history as the economic equivalent of the Pol Pot regime. The hurt later school, by contrast, are choosing the financial equivalent of releasing a latent Ebola virus into their population, to be manifested at some time in the future.


The Austerity Dilemma

As the G20 meeting get under way in Toronto, it is evident that not all is well and the posturing began long before the summit.

Despite the soothing offical pronouncements, it is evident that the US position is a source of division at the G20 meetings. In Europe, the cult of austerity has caught fire. The UK has passed a high profile austerity budget (see analysis here) and so has Germany. Nevertheless, the G20 remains divided. On this side of the Atlantic, US officials are urging G20 to avoid growth dampening budget cuts.

What gives?