November 30, 2010 falconadmin

Eurozone crisis: Sovereign debt back in the headlines. Portugal, Ireland and Greece bond spreads near their highest yields, again. Irish bankruptcy was avoided with a 130 Billion bailout for its banking sector. Greece and Portugal’s prospects are dismal. Germany said that if borrower nations are unable to repay their debts, then it is their creditors that ought to bear the losses, not the Eurozone in total. Brave hope.

G20 meeting in Seoul worried about the unbalanced world recovery, but did not come up with any solutions.  Countries blame each other for distorting global demand. There are three battles: China’s unwillingness to address its currency formula; second is the rich world’s monetary policy. The US Fed may restart printing money; third, how developing economies use the capital inflows. Since sluggish growth may infest the rich world for many years, the prospect of a currency war cannot be ignored. Global demand needs rebalancing towards spending in the emerging world. China needs to get more of its growth from domestic consumption. Core economies fear the US decision of quantitative easing which will pump additional $600 Billion into its economy. They fear it will create capital flows into weaker economies less capable of adequately using the capital, thus creating inflation and of course they worry that the program will further weaken the US dollar.

China holds by far the largest stockpile of foreign exchange reserves- $2.6 Trillion, 65% in US dollars. China is interested in diversifying. What they do with those reserves is subject of much speculation. Recently it purchased Japanese sovereign debt, amounting to $25.5 Billion, thus driving up the value of the yen versus US dollar 15%. Once Japan released the Chinese fisherman held for fishing in Japanese waters, China sold its Yen bond holdings creating a commensurate lowering of the yen/us dollar rate. Chinese currency undervaluation results from its currency policy, pegging to the US dollar. Only if it were to peg its currency to a basket of currencies, would it gain leeway in exporting its reserves.   All this cries out for a multilateral approach using IMF and the G20 to forge a consensus among the big economies. Re-double efforts that avert, not fight a currency war.

Creating jobs is the number one task of the US economy. Unemployment hovers around 9.5% with scant evidence of improvement. Why the scant evidence? High household debt and a shift away from how many employers think about hiring. High mortgage debt allows little spendable cash. Government should consider calming the foreclosure wave. Some program of reducing loan defaults and improving household finances might prompt banks to write down the principal value of at risk loans.

As for jobs, the traditional floor job model no longer applies. Unemployment remains at 9.6% in spite of adding over 150,000 jobs last month. US requires innovative jobs using technologies recently minted and the government should grant a payroll-tax holiday; extend the Bush tax cuts; cut back on government spending because high public debt harms the economy.   More could be done to provide re-training, re-education for unemployed by, for example, easing access to community colleges where more appropriate skills can be learned.

Bond markets have had it. Obama’s Deficit Reduction Commission means deficit needs to be addressed. Medium debt reduction would provide room to create more fiscal stimulus.

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