According to the chairman of the forum of eurozone finance ministers, Jean-Claude Juncker, recent weakness of the euro (which has slumped by 7% against the US dollar in recent weeks) is an example of currency markets being irrational. As the eurozone frantically runs their money-printing machines, Juncker told Reuters, “There is a certain reluctance to believe the Greeks can overcome the current crisis. I don’t think the markets are behaving in a rational way.”
Someone apparently forgot to tell Juncker that what is happening in Greece is not so much a crisis, but an inevitability. That is, when you spend more than you earn, and have to borrow money to make up the difference, eventually your lenders wise up to the fact that you won’t be able to repay the debt.
When that happens, the cost of borrowing (known to us as ‘interest payments’) increases. The short-term fix announced last week is little different to placing a bandaid on a tetanus-infected wound. It appears to cover up the problem, but all the while, things are getting worse. Now investors are realizing that Greece is merely a portent for problems across the eurozone, and that a single currency which denies the ability for individual states to control monetary policy or allow their currency to devalue is a terrible idea. Despite Juncker’s best claims, it appears that the markets are finally getting a dose of reality, even if they have been a little slow to react.
But while the eurozone is coming to grips with its recent unpopularity with investors, the so-called recovery in the US is showing little real evidence of being sustainability. Reported unemployment remains stubbornly at just under 10% (in reality, the US jobless rate is probably closer to 20%), while the property market remains supported not only by government grants (the US have been running a policy, similar to Australia’s much-maligned first home owner’s grant, in which buyers receive a US$8,000 credit) but is also literally being kept afloat by US taxpayers.
It was announced yesterday that the size of the US Federal Reserve’s balance sheet expanded to record levels after the Fed committed to purchasing a further US1.25 trillion in mortgage-backed securities. The Fed would only have bought the securities because no-one else wanted to.
Fannie Mae and Freddie Mac, who have already received US$127 billion from US taxpayers, last week sought a further US$19 billion after both recorded multi-billion-dollar losses in the December quarter last year. The twin companies were creations of the US Government, established to buy mortgages from lenders, turn them into bonds (known as mortgage-backed securities) and then sell those bonds to investors. The problem is that, after the sub-prime crash, no-one wanted to buy US housing assets, and the US Government were forced to buy F&F and continue to fund their loss-making activities.
If you’re wondering why F&F would continue run a business that loses so much money, the answer lies in what its owner, the US Government, is using them for — that is, to keep the US property market from sinking even further. Inside Mortgage Finance calculated that almost 97% of home loans made in the March quarter of 2010 were backed by Fannie or Freddie.
To simplify it all: the US taxpayer is currently buying mortgages because the market thinks they are over-priced. The market is saying, “We don’t want to buy US housing.” Instead of listening, the Government is stepping in to create a false market. Dean Baker, co-director of the Center for Economic and Policy Research recently told the New York Times, “If [F&F] are deliberately paying too much for mortgages to support the banks, the government wants them to be in a position to keep doing that, and that would mean not doing anything about their status until further down the road.”
Amazingly, despite its own problems, the US is also funding part of the trillion dollar European bailout (via the IMF).
Meanwhile, share markets across the globe also continue their correction as investors continue their ‘flight to safety’. Overnight, the broader US S&P500 index slumped by 3.9% and is down 8.5% since 26 April. The Shanghai composite index has dropped by 23% since last November as the Chinese bubble shows signs of deflating. European markets were down by around 2% overnight.
The Australian bourse has already felt the shocks of the overseas falls, dropping 14% since mid-April. It seems like the Treasury should be taking a close look at its bullish forecasting, and the so-called benefits of the planned mining super-profits tax, which may turn out to be a super-refund for mining companies.
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