A Few Miscellaneous Thoughts

Currency in Crisis

The G20 meeting this weekend is shaping up to play an important role in addressing the European debt crisis. A senior conservative German member of parliament indicated that the German vote on Greek 2.0 is partly a function of the IMF`s involvement. In earlier euro zone packages the IMF was good for a third of the funds.

In Greek 2.0, the preliminary figures suggested a considerably smaller role. The may be pressure from a greater role for the IMF, but itself may be linked to greater contributions. While Japan and to a lesser extent China appears sympathetic, many other countries, including the US, do not seem prepared. Instead look for some push back on Europe's official sector to do more.

Two aspects seem particularly relevant. The first is to allow the EFSF and ESM (which is to be launched in July and had about €80 bln in paid up capital) to run concurrently. The EFSF has an estimated €250 bln of uncommitted capacity. The secondis to increase the funds available to the ESM, which German is opposed.

In this regard, the international community make take on the quasi-theological position of being more willing to help those that help themselves.

There is understandably much interest in next week's LTRO. It seems the risk is that it is anti-climactic. Rather than start something it marks the end.

Starting late last year, the major central banks have expanded their balance sheets and in other ways, expanded liquidity. The BOE, BOJ, and PBOC joined the ECB. The Federal Reserve is changing the composition of its balance sheet, but is not expanding it. The second LTRO next week ends this chapter.

Barring QE3 in the US, which we continue not to think is particularly likely, especially in H1, we don't expect additional easing in the coming months. That said, another cut in China's reserve requirements in Q2 may be the next move. In any event, the point is that at least this phase of monetary expansionis like nearly over.

Monday, which is typically a slow day, may be more interesting than usual. Two announcements from the ECB will attract attention. First is money supply. In the last report there was some evidence of a credit crunch. The key issue is whether the LTRO in December helpd stabilize the situation.

Among developed countries, the money multiplier has broken down. Growth in central bank balance sheets and high power money has not translated into greater money supply (M1, for example). This is a transmission mechanism that is still not properly functioning.

The ECB will also indicate how mch bonds were settled this week. Recall last week no bonds were settled. This has spurred talk that the SMP program is done.In sme ways, then Draghi has substituted the less controversial LTRO for the sovereign bond purchase program. Two weeks without buying bonds may drive home the point.

At the same time, perhaps it is like QE in the US. Just because te Fed is not presently engaged in long-term asset purchases doesn`t mean that it won`t or will a priori deny itself a tool, which it argues can be effectively deployed.

Monday the German parliament is to vote on Greek 2.0. The cost to Germany is greater than many appreciate. It turns out that Hypo Real Estate that was bailed out in 2008 and nationalizedin 2010 spun off its toxic asets, which included an estimated €6-8 bln in Greek bonds, to EMS Wertmanagement, a "bad bank", which wharehouses and later packages and sells those assets. Whether it is the federal German agency Soffin or EMS, the PSI is going to cost Germany more money that may have been realized.