Interesting dynamics at work. Trade can drive the currency and/or the currency can drive trade.

Looks to me like early on it was the trade that was driving up the currency, But more recently the currency looks to be driving trade.

That is, portfolio managers have been shifting out of euro due to the crisis, cheapening it to the point where the trade flows are on the other side of their portfolio shifting.

For example, someone selling his euro for dollars is effectively selling them to an American tourist buying tacos in Spain. Euros shift from the portfolio manager to the Spanish exporter.

Trade flows are generally large, price driven ships to turn around, and continuous as well. Portfolio shifts, while they can also be large, are more often ‘one time’ events, driven by fear/psychology, as has likely been the case with the euro. So a turn in psychology that ‘rebalances’ portfolios to more ‘normal’ ratios can be very euro friendly.

>   (email exchange)
>   This was an interesting chart from Nomura that came out over the weekend discussing
>   the current account against the portfolio flows – suggests that the portfolio flows
>   have turned significantly negative for Europe and are much bigger than the positive
>   effects of the current account.

Yes, agreed. this says much the same story I was telling, only better!

11 Responses

  1. Yes, mountain of people ran out of the euro and their return would stimulate the euro. Looks however that their psychology is not going to change if there is no structural solution. Also the longer it drags on, the more people who left will find a place for their money where it is treated better.
    As you mentioned before that is like Madoff trying to start again after having been caught.

    1. @walter,

      A friend of mine says that when the ECB removed interest on reserves the reserves at the ECB dropped from about EUR 900 Billion to about EUR350 Billion in just one week. Looks like that money flowed into U.S. Treasuries in search of safe haven and some minimal yield.

      He reckons that if the Fed cuts or eliminates interest on reserves there will be a similar shift from excess into Treasuries which offer similar liquidity and security while also offering some yield in the 5yr to 10yr maturity sector. This should reduce interest rates on those instruments….where, ironically, if the Fed did QE III targeting those Bonds, the rates on those bonds would likely rise.

      He goes on to say that the other side of this action instead of direct buying of Treasuries or agency debt, is that it will not create new base money…it will simply reallocate existing reserves into lateral risk instruments. Understanding that, we should not expect any support for equities, gold, energy or commodities from that action if there is no direct new purchase of Treasuries.

      1. euro balances at the ECB can’t ‘flow’ into $US balances at the Fed.
        they must have been used to pay down loans at the ECB or something like that.

      2. @WARREN MOSLER, From what I understood the ECB reduced the interest rate on the deposit facility to zero in early July after which it became effectively the same as current accounts that already did not give any interest. So probably balances were just flowing from deposit facility to current account.

        These 2 accounts you can see at the link below to the ecb’s balance sheet, page 202.

      3. ecb loans create ecb deposits which exist only on the ecb’s books. they can’t go anywhere.
        and paying down ecb loans reduces ecb deposits.

      4. @WARREN MOSLER,

        Why can’t European banks withdraw reserve deposits from the ECB and convert to USD to purchase U.S. Treasuries? The excess reserves would decline and the assets on the bank balance sheet for U.S. Tsy securities would go up……. no? Right after the ECB cut interest on reserves, not only did the reserves drop, but the Euro itself dropped dramatically and the U.S. 10-year Tsy yield fell sharply.

      5. they can buy dollars but can’t ‘convert’ as there is no such thing.
        when they buy dollars the euro just goes from the member bank account of the seller of euro to the member bank account of the buyer of those euro

  2. How about the ecb issuing euro bonds? Would’t that return a lot of the net portfolio outflow?
    China’s central bank also issues bonds.

    1. the only thing that will ‘return net portfolio outflow’ which is the act of portfolio managers selling euro and buying some other currency,
      is for portfolio managers to start buying euro.
      Yes, ECB bonds might cause them to do that.

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