A group of colleagues asked me two weeks ago what interest rates were going to do. I answered in an authoritative voice, "They’ve been in the same place for seven months — it’ll take an earthquake to move them."
Ahem. The opinion was correct, but I was clueless about the proximity of the quake. An "F" for that.
In one week the Fed announced no MBS-buying QE3, U.S. economic data improved, and Europe re-re-floated Greece.
Until one or more of those three things change, technical analysis is the usual guide, looking for chart-pattern "support."
There is none of that, either. The 10-year T-note fell from 3 percent last August to 2 percent in a single, straight-line month, and spent very little time north of 2.15 percent in the next seven months.
Having now blown up near 2.4 percent, 10s are in Never Never Land, likely to wander in a wide range until something happens, mortgages 4.25 percent or more.
So, while waiting for something to happen, let’s explore what is really happening in Europe — and why it will remain defiant of solution.
The real problem is not profligacy by Club Med, or tax evasion, or even too much debt. The real problem is trade imbalance among nations locked in the equivalent of a gold standard.
All civilians’ eyes glaze at technical descriptions of currency movements and the interlocked European thicket. But we have a new single-nation example — Brazil — to use for a nontechnical explanation.
Brazil has enjoyed a red-hot economy for two reasons: resource exports to China, and manufacturing highly stimulated by government-induced credit. To prevent red-hot growth from turning into inflation, Brazil’s central bank by last summer raised its interest rate to 12.5 percent, the highest among modern nations.
With an interest rate so high — Brazil’s 9-year government bonds pay 11.4 percent — investment money has poured into Brazil to take advantage. Which in turn pushed the real to stratospheric levels versus the low-interest-rate rest of the world. As the real rose, it began to harm Brazil’s exports, especially its new and booming manufacturing.
So Brazil’s leadership has tried to limit the flood of cash into Brazil, installing capital controls two years ago to reduce the inflow. Today, foreign cash earns less (net of fees and penalties) than domestic cash. Money came anyway, the interest-rate differential overwhelming.
Brazil’s economy has begun to slow — almost to zero — under the weight of rates set to stop inflation, and the sky-high real. The central bank has cut its rate to 9.75 percent, but cash is still pouring in.
So, last week Brazil announced new measures, every one a violation of some trade agreement or another, to weaken the real while leaving high rates, exports and manufacturing in place.
The basic method: Print a mountain of real and see if it can get foreigners to take them, but do no domestic harm. Right.
Brazil is an example of one nation trying to manage inflation, exports, manufacturing and economic growth in a world in which all emerging players (and some emerged: Japan) are trying to get an edge on the others via the same manipulations.
Europe, on the other hand, is 17 nations — each with one form or another of Brazil disease (or success) — but only ONE currency. European countries with trade deficits cannot print euros to make their exports cheap.
Countries with trade surpluses — think Germany — believe fortune smiles upon them because of their special genius, not because the euro is undervalued for them.
All countries in the euro zone have the same central bank. Rates and money are too high and tight for the weak, too low and loose for the strong.
The only "give" in Europe is wages. The strong feel rich, and they are. Wages are rising in real, noninflationary terms, but their economies are at risk of asset bubbles. In the weak "Club Med" countries, wages must fall 30 percent or more to make exports competitive. Cut wages like that, and workers cannot pay debts and taxes.
One could ask why Brazil does not just drop all the shenanigans, play it straight and let the real find an appropriate level.
In Europe, the weak have one choice: Become good Germans, no matter what the price. Debt is a sideshow; trade and currencies are the real deal. And I still think Club Med will tire of taking orders from the North.
