Brace Yourself , Europe Central Bank Goes Italian and Just How Bad Will the S&P Downgrade Be?

Just when you think you've had enough, here comes Italy. The European Central Bank is buying Italian and Spanish government bonds on a massive scale. From the ECB press statement:

The Governing Council of the European Central Bank (ECB) welcomes the announcements made by the governments of Italy and Spain concerning new measures and reforms in the areas of fiscal and structural policies. The Governing Council considers a decisive and swift implementation by both governments as essential in order to substantially enhance the competitiveness and flexibility of their economies, and to rapidly reduce public deficits.

The Governing Council underlines the importance of the commitment of all Heads of State or Government to adhere strictly to the agreed fiscal targets, as reaffirmed at the euro area summit of 21 July 2011. A key element is also the enhancement of the growth potential of the economy.

The Governing Council considers essential the prompt implementation of all the decisions taken at the euro area summit. In this perspective, the Governing Council welcomes the joint commitment expressed by Germany and France today.

The Governing Council attaches decisive importance to the declaration of the Heads of State or Government of the euro area in the inflexible determination to fully honour their own individual sovereign signature as a key element in ensuring financial stability in the euro area as a whole.

QE2 Has Arrived - Fed to buy $900 Billion in U.S. Treasuries

The long awaited day is here. In the spirit of QE2, aka quantitative easing part II, the Federal Reserve has announced $600 billion in U.S. Treasury purchases:

The Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

Also, the thing every one knows, they will keep the Federal Funds Rate at effective zero and sure doesn't look like they will raise it anytime soon:

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

Kansas City Fed President Thomas M. Hoenig voted against this.

But wait! There's more. From the New York Federal Reserve press release is appears they are actually buying up about $900 billion U.S. Treasuries de facto.

Not ready for prime time: Some ideas on the relationship between gold and depressions

Barry Eichengreen and Kevin H. O’Rourke have been updating us on the progress of this depression by comparing it to the big one, The Great Depression. Their original post, in April 6, 2009, captivated their audience.

One thing that struck me was that we might compare the two events to the totally overlooked depression of the 1970s – The Great Stagflation. The reason why this one is missing and, perhaps, lost from official economic history is that it did not look anything like how we expect a depression to look – at least by the accepted, albeit vague, standard of what constitutes a depression. For instance, as shown in the graph below, year over year Gross Domestic Product enjoyed an unbroken expansion during the entire period.

USGDPYOY - 1970-1980.jpg

Chart 1 (Source: Bureau of Economic Analysis)

Compare this performance to the contraction of GDP during the Great Depression

USGDPYOY%20-%201929-1933.jpg

Chart 2 (Source: Bureau of Economic Analysis)

A Couple of Short Articles on a Dollar Comeback

The dollar is rebounding and there are a couple of quick articles to read.

First is The Financial Times quoting the drop off in dollar shorts:

Figures from the Chicago Mercantile Exchange, often used as a proxy of hedge fund activity, showed investors cut their net short positions in the dollar from 172,367 contracts on December 1 to 107,284 contracts on December 8.

The fall in bets against the dollar, which had a notional value of $9.8bn, was by far the biggest weekly positioning shift of 2009, and the largest since July 2008.

This is partly betting the Fed will wind down loose monetary policy.

Another article is Bloomberg:

The Never-ending Dollar Decline

The Dollar bottom is forecast to be a long way away according to most forecasters.

The most accurate dollar forecasters predict the world’s reserve currency will continue sliding even when the Federal Reserve begins to raise interest rates, which policy makers say is an “extended period” away.

Standard Chartered Plc, Aletti Gestielle SGR, HSBC Holdings Plc and Scotia Capital Inc. say the dollar will depreciate as much as 6.4 percent versus the euro. About $12 trillion of fiscal and monetary stimulus, the world’s lowest borrowing costs and a record $4 trillion of government bond sales between 2009 and 2010 will weigh on the currency, they said. So will the nation’s 10.2 percent unemployment rate and signs that the economic recovery may falter, they said.

and look at this statistic:

Gold, the dollar and China

So what it's true? A Chinese official trashed our currency, so the dollar is down and gold reaches another high.

"The continuous depreciation in the dollar, and the U.S. government's indication that, in order to resume growth and maintain public confidence, it basically won't raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation," Liu Mingkang, chairman of the China Banking Regulatory Commission, said Sunday in Beijing at the International Finance Forum, according to news reports.

Meanwhile Gold is at another high:

This is a different type of gold rally, with support coming from both sides of the market -- investment [and] fundamental," said Darin Newsom, a senior analyst at Telvent DTN.

IMF validates Roubini on Dollar used for carry trade

Bloomberg reports IMF Says Overvalued Dollar Used for ‘Carry Trades’ :

The International Monetary Fund said traders are probably using the dollar to fund “carry trades” across the world and the currency may still be overvalued even after its slide this year.

“There are indications that the U.S. dollar is now serving as the funding currency for carry trades,” the IMF said in a report published today. “These trades may be contributing to upward pressure on the euro and some emerging economy currencies.” While the dollar “has moved closer to medium-run equilibrium,” it is still “on the strong side.”

The IMF is also warning on the Chinese currency being significantly undervalued. We've covered China's currency manipulation many times and noted almost all of the U.S. trade deficit with China can be attributed to Chinese currency manipulation.

Stiglitz argues for the U.S. to get on the global reserve currency bus

In a new op-ed Joseph Stiglitz argues that due to the national debt (projected to be $9.05 trillion over the next 10 years), America should get on the we need a new reserve currency beyond the dollar bus. Kind of a if you can't beat 'em, join 'em message. (see China and the Dollar for details on the Chinese game of chicken while pushing for a new reserve currency).

Our budget deficit, as well as the Federal Reserve's ballooning lending programs and other financial obligations, will accelerate a process already well underway -- a changing role for the U.S. dollar in the global economy.

Is the collapse of the dollar inevitable?

The socialists and the Austrians are at opposite ends of the spectrum of views on inevitability. Socialists believe that the government can turn on a dime, veering away from economic collapse towards a socialistic paradise simply by giving the right person the authority to print money. And how would the Benevolent One accomplish this feat? According to the Debt Virus Theory, it is as simple as printing money and spending it directly into the economy, rather than buying Treasury Bills. On the other hand, the Austrians believe that a “distortion-reversion process” is inevitable. Credit expansion is unsustainable and this, apparently, is true no matter how benevolent the chairman of central bank may be and no matter what he spends newly created money on, whether on social programs or in the discount of good bills, at not more than sixty days’ date.

Is hyperinflation the inevitable result of inflation? This is the question I address.

China Decoupling from the Dollar - Enabling Yuan Currency Swaps

Anyone have some good analysis on what happens if China stops buying U.S. debt? Bloomberg is reporting China to Boost Yuan Swaps, Payments on Dollar Concern:

China’s leaders, increasingly concerned about the nation’s $740 billion of U.S. Treasuries, are making it easier for trading partners and consumers to do business in yuan.

The People’s Bank of China has agreed to provide 650 billion yuan ($95 billion) to Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea through so-called currency- swaps. More such arrangements are being planned so importers can avoid paying for Chinese goods with dollars, the central bank said. In Hong Kong, which has pegged the currency to its U.S. counterpart since 1983, stores from Park’n Shop supermarkets to jewelers accept yuan.

Dollar