Asian players are a worry for eurozone

By Gillian Tett

July 14 (FT)

The saga behind next week’s stress test release is a case in point. During most of the past year, governments of countries such as Germany, Spain and France have resisted the idea of conducting US-style stress tests on their banks, in spite of repeated, entreaties from entities ranging from the International Monetary Fund to the Bank for International Settlements, and the US government.

However, after a meeting of G20 leaders in Busan last month, those same eurozone governments performed a U-turn, by finally agreeing to publish the results of such tests.

Some observers have blamed the volte-face on lobbying inside the senior echelons of the European Central Bank. Others point the finger to American pressure. In particular, Tim Geithner, the US Treasury secretary, had some strongly worded discussions with some of his eurozone counterparts in Busan, where he urged – if not lectured – them to adopt these tests.

However, Europeans who participated in the Busan meeting say it was actually comments from Asian officials that created a tipping point. In the days before and after that G20 gathering, eurozone officials met powerful Asian investment groups and government officials who expressed alarm about Europe’s financial woes. And while those officials did not plan to sell their existing stock of bonds, they specifically said they would reduce or halt future purchases of eurozone bonds unless something was done to allay the fears about Europe’s banks.

That, in turn, sparked a sudden change of heart among officials in places such as Germany and Spain. After all, as one European official notes, the last thing that any debt-laden European government wants now is a situation where it is tough to sell bonds. “It was the Asians that changed the mood, not anything Geithner said,” says one eurozone official.

This raises some fascinating short-term issues about how the bond markets might respond to the stress tests. It is impossible to track bond purchase patterns with any precision in a timely manner in Europe, since there is no central source of consolidated data.

However, bankers say there are signs that Asian investors are returning to buy eurozone bonds. This week, for example, China’s State Administration of Foreign Exchange bid for €1bn (£1.27bn, £835m) of Spanish bonds, helping to produce a very successful auction.

Yes, it’s a two edged sword.

Asian nations want to accumulate euro net financial assets to facilitate exports to the euro zone.

Before the crisis euro nations were concerned that the strong euro, partially due to Asian buying, was hurting euro zone exports

However, as the crisis developed, euro nations got to the point where they were concerned enough about national govt solvency and the precipitous fall of the euro (which was in some ways welcomed by exporters but worrying with regards to a potential inflationary collapse) to agree to measures to support their national govt debt sales which also meant a stronger euro.

So now the pendulum is swinging the other way. Solvency issues have been sufficiently resolved by the ECB to avert default, but at the ‘cost’ of a resumption Asian buying designed to strengthen the euro to support Asian exports to the euro zone.

As before the crisis, however, the euro zone has no tools to keep a lid on the euro (apart from re introducing the solvency issue to scare away buyers, which makes no sense), as buying dollars and other fx is counter to their ideology of having the euro be the world’s reserve currency.

So the same forces remain in place that drove the euro to the 150-160 range, which kept net exports from climbing.

The export driven model is problematic enough without adding in the additionally problematic idiosyncratic financial structure of the euro zone.

As for the stress tests, as long as the ECB is funding bank liabilities and buying national govt debt banks and the national govts can continue to fund themselves with or without Asian buying.

I’d have to say at this point in time the euro zone hasn’t gotten that far in their understanding of their monetary system or they probably would not be making concessions to outside forces.

3 Responses

  1. “With unemployment still painfully high, job creation must be a high priority of monetary policy,” said Janet Yellen in testimony to
    the Congressional appointment panel.

    A good follow up by the panel would have been:
    “With nearly 0% FFR, what else can the fed do and why hasn’t
    the near 0% policy created jobs?”

  2. I think it’s important to recall that EMU and the ECB have an architecture that reflects heavy Bundesbank influence. This architecture only really works if internal devaluation (price flexibility) can be relied upon as an adjustment mechanism. There are no effective mechanisms to coordinate national fiscal policy, and the EU budget cannot itself take on this role. Another ten years of slow growth ?

  3. What happens if these Asian countries begin to trade a bit with their reserves and decide to drive a knife into the heart of the Eurozone by putting the Euro up another 1000 pips?

    “As before the crisis, however, the euro zone has no tools to keep a lid on the euro (apart from re introducing the solvency issue to scare away buyers, which makes no sense), as buying dollars and other fx is counter to their ideology of having the euro be the world’s reserve currency.”

    There is the additional pressure of non-systemic insolvency. If the world starts to think the Eurozone isn’t going to systemically fail, but the individual bank failures continue, then the demand for cash becomes very high within the Eurozone as well as outside of the Eurozone.

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