Euro Train Wreck
Research for Online Investors

by John Dalt

3/25/10

Can the Euro survive divergent economies and governments?  The European Central Bank (ECB) announced today they would continue to accept collateral from Eurozone banks with reduced credit ratings past the previous deadline of December 2010.  This move was to help Greece as their banks can access ECB short term loans with Greece bonds as collateral.

Many of Greece’s banks own government debt, so they will be able to continue to pledge it as security to the ECB in the future.  The ECB interest rates are artificially low, as are the U.S. Fed Funds Rate.  This move effectively allows Greek banks to continue to buy government debt with ECB money.  This action will exert downward pressure on the bond market in Greek debt.

This is not unlike what the U.S. Federal Reserve has done in the U.S. debt market.  They have openly bought U.S. Treasuries, but also have encouraged primary dealers to buy debt and then bought it from them the next week behind closed doors.  This has masked the involvement of the Fed in the auctions.  The market cannot know exactly how much of the purchase volume is actually supported by the Federal Reserve.

The debt auctions in the U.S. this week may give us some insight to how much influence the Fed has on Treasury interest rates.  Five year bonds yesterday slumped as did the seven year auction today, as bidders demanded greater discounts.  The Fed announced last winter they would discontinue buying Treasuries at the end of March 2010.

We should not be deceived, the Fed may still be involved in the Treasury auctions next week, only behind the curtain.  While they cannot buy in the open as an indirect bidder, they do accept treasuries as collateral for loans, and may buy Treasuries from Primary Dealers or other direct bidders.  They can do this because they do not have to disclose this information.

Buyers pulling away from Treasuries can also be explained by the current bull run in the stock market.  Investors may feel they are missing out on an opportunity in equities and start to move some money to stock accounts and away from fixed term investments.  When the market fell last year we saw money flow out of equities and into the security of fixed term investments.  It was considered safer to make a safe one or two percent rather than possibly lose another 10% in stocks.

Midday, the European Central Bank’s president Jean-Claude Trichet was quoted that it would be a failure of the eurozone countries if they were not able to fashion a package for Greece.  This sent the euro into the tank and bolstered the dollar.  Later in the day, a proposal to aid Greece, and other eurozone countries, seemed to be taking shape.  The proposal involves the IMF and does not promise cheap loans to Greece, only the ability to access the credit markets to sell debt.  The proposal “will not be to provide financing at average euro area interest rates but to set incentives to return to market financing as soon as possible by risk adequate pricing."

Chancellor Merkel extracts blood from Greece

German Chancellor Angela Merkel is driving a hard bargain.  Aid would only be available after Greece has exhausted all other options to pay off its debts.  Aid would require stronger surveillance of the Greek economy and strengthen enforcement of the EU’s budget limits on debt and deficit spending.  Merkel wants to make sure that eurozone nations learn a lesson from Greece’s financial crisis, and toughen sanctions against countries that run budget deficits above three percent of the country’s GDP.  Merkel said, “There must be an end to cheaters.”

Will Chancellor Merkel be able to enforce fiscal discipline on an unrully Greece union?  We don't know, but they should remember, the are dealing with a woman that grew up behind the Iron Curtain.  I wouldn't fool with her!

Have you heard about McDonald's' new Obama Value Meal?  Order anything you like and the guy behind you has to pay for it.---Conan O'Brien

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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