FIGS vs Germany
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8/01/12

The push and pull playing out in the eurozone between central bankers and governments is interesting to watch. We have chronicled Mario Draghi’s statement that the ECB "would do whatever it takes to save the euro.” The U.S. Treasury Secretary, Tim Geithner, visited Germany and the ECB on Monday.

Upon his return to the U.S. Geithner told Bloomberg the eurozone must take strong action to bring “down interest rates in the countries that are reforming and making sure those banking systems can provide the credit those economies need.”

Italian Prime Minister Mario Monti hailed Draghi’s pledge as “bold and appropriate.” He believes European leaders should authorize joint intervention by the ECB and the EFSF to lower interest rates.  Monti wants the ESM to be granted a banking license so they can lever their balance sheet by borrowing more money from the ECB to buy ever more bonds.

Monti is visiting other eurozone capitals to build support for an “activist” ECB.  He is not visiting Germany, as the trip is to encourage other countries to pressure Germany in future decisions.  Francois Hollande of France wants the ECB to “do everything” to save the euro (and keep cheap money coming).

We will call this “lose money” policy the French, Italian, Greece, Spanish (FIGS) model. On the other side is Germany, the fly in the ointment. Germany wants to follow the rules. Germany believes the European Central Bank needs to fight inflation and insure the value of the Euro.

German Vice-Chancellor Philipp Roesler said “If you take away the interest rate pressure on individual states, you also take away the pressure on them to reform.”  Germany knows that other European countries would drop hard political reforms immediately without the discipline forced on them by higher interest rates.  We call this the German model.

Mario Draghi met Bundesbank President Jens Weidmann on Monday to discuss his statements from last week.  This morning, the Bundesbank put an interview from June 29 on their website.  In the interview Weidmann said “Politicians overestimate the central bank’s capacity and place too many demands of it.  Whether it’s about interest rates or any sort of special measures, in the end it always comes down to the same thing: trying to rope the central bank into meeting fiscal policy objectives.”

The Financial Times has a good article on the relations between the Bundesbank and other eurozone countries along with the ECB.

Two weeks ago, Ben Bernanke appeared before the Senate Banking Committee.  Forbes wrote that Senator Charles Schumer (D-NY) told Bernanke 'that Congress will not be able to get its act together until it is too late to stave off the impact of the fiscal cliff looming in January...Schumer urged Bernanke to take whatever action he thinks necessary.'  Schumer told Bernanke, “Get to work Mr. Chairman.”

What is the monetary policy of the U.S.? Do we follow the German model of sound money or the FIGS model where monetary policy is used to finance debts that allow politicians to keep spending?

We do not expect the Federal Open Market Committee (FOMC) to initiate quantitative easing today.  Perhaps they will hint at it and leave the decision until September.  We expect the ECB to lower interest rates tomorrow morning, but little else in concrete action as they need unanimous approval and will not go against the Bundesbank.

The market is in the top of the bullish trading channel that has built since the end of May.  We expect the market to visit the bottom of the channel in the next few days to see if support at 1330 to 1345 on the S&P will hold.

The Mailbag:
Bandar's purported death, if true, makes him the only person I've known personally who died in the War On Terrorism  I met him years ago in Washington DC when he was a major serving as air attaché. Last time I saw him was in his embassy when he was ambassador.  Amazing that, of all those who died since 9/11, he's the only acquaintance of mine who became a causality. Hope he's the last.---subscriber J.R.

John’s reply: Me thinks you are being overly optimistic.  As long as there are men with fanatical beliefs there will be conflict.  Terrorism is a "soft" way to inflict damage against a superior opponent.

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