Thursday, 30 May 2013

Does Frau Merkel and Friends Have a New Economic Plan?

Ralph Shell, Excel Analyst

For months countries in the Southern Euro Zone have been complaining about the German recovery plan.  Austerity, combined with reforms to make the public sector more efficient has been a failure where ever tried.  Perhaps there will ultimately be a competitive revival, but the price is very high. 

Unemployment in the eurozone is at record highs, with youth unemployment as high as 60%.  This is a tragedy.  When given a chance at the ballot box, voters throw the incumbents out.  In the last vote in Italy, not only did they elect new representatives, but over 55% of the votes went to those that want out of the euro.

How long will the unemployed remain docile, accepting their situation?  So far, the riots seem to be confined to extremists but it can change quickly.  Misery knows no borders, and eventually a populist leader will emerge.  This is the risk going forward, should there not be a recovery.

For Germany there are additional risks. A long hot summer, with riots and anti-euro protests would not be a nice compliment to Merkel's re-election campaign.  In many countries, there is a seething resentment of the plan and its authors.  In addition, Germany is an exporting country, and importing countries who are in a prolonged recession are poor customers.

The reversal of the government's position was summarized in Spiegel:

"The government's change of heart isn't just a sign of selflessness and compassion. More than ever, the chancellor and the finance minister are worried that Berlin's tightfisted, heartless, austerity-obsessed image could solidify throughout Europe and do irreparable political damage. An exporting nation that sells two-thirds of its exports to other European countries cannot be unconcerned about its image abroad, they reason, especially when its government fears that constant criticism from the center-left Social Democratic Party (SPD) and the Green Party, claiming that it is acting as the gravedigger of the euro and dividing the EU, could hurt it in the upcoming election campaign."

Critics of the austerity plan have long complained there has been no stimulus, and therefore no job creation.  Further, banks who are sitting with bad loans are not eager lenders to finance small private sector business. 

To enable funds to be available for business loans in the Med countries, the Germans intend to use a government owned KfW development bank to enter in partnership with Spanish and Italian banks to make private loans.  Currently, ten-year notes are yielding 1.52% in Germany and the money cost in Spain and Italy is above 4%.  Private loans would depend on the risk, but lending at a 7/10% rate would be a nice margin.  It might be high, but for many businesses there are no other funds available.

The EU has also relaxed deficit deadlines for Poland, Slovenia, Portugal, Netherlands, Spain, Italy and a few others.  It looks like the EU received a heads-up on Merkel's new election strategy.

The euro has responded to this news positively.  After trading early at 1.2837 versus the USD, it has since rallied to 1.2970 before settling back.  It is too early to see if this is a game changer.  As a skeptic, I am inclined to think this is an election ploy, more symbolism than substance. 

Click to Enlarge EURUSD Daily Forex Chart

That said, however, our latest COT Report show the speculators have been on a USD buying binge.  Speculators were reported long over 520K of USD's and short something else.  This means the specs are short (EURUSD, FXE,  UUP, UDN).

I doubt the new German/EU plan will do much to improve the sick European economies, but the market may be too short.  Should the market take out the top side of 1.30, this might create a short squeeze.  As always, mind your money.
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