Most of the major figures in the financial crisis have had an “insert foot in mouth and chew” moment, although none have yet proven as memorable as Irving Fisher’s “Stock prices have reached what looks like a permanently high plateau.” less than a week before the Great Crash of 1929 commenced.
Bernanke’s was his March 2007 Congressional testimony, in which he argued that the subprime crisis was contained. He further estimates losses at $50 to $100 billion. I recall gasping out loud when I read that; loss forecasts from private sector analysts at that juncture were $150 billion or more. Similarly, Hank Paulson contended when he asked for authority to rescue the GSEs that it was more powerful if it was substantial: “If you’ve got a squirt gun in your pocket you may have to take it out … If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.” As we have seen again and again, the markets have a nasty way of calling bluffs. Paulson put Fannie and Freddie into conservatorship less than two months after his comment.
Geithner’s moment may have arrived. In a Bloomberg TV interview (to be aired), the Treasury Secretary maintained that Europe could surmount any sovereign debt related challenges and the US economy would be unscathed:
“Europe has the capacity to manage through this,” Geithner said in an interview today on Bloomberg Television’s “Political Capital With Al Hunt,” airing this weekend. “And I think they will.”
Geithner, 48, said he doesn’t think the European turmoil will hurt U.S. growth because “our economy is getting stronger. We’re seeing a lot of strength, improvement and confidence.”
Yves here. Geithner is cautious enough that this (sadly) does not contain a crisp quote that could come back to haunt him, but the message is unambiguous: l’affare Euro is strictly local, of no serious import to the US.
Let’s see how credible this whistling in the dark is. From the EU Trade Commission:
The EU and the US economies account together for about half the entire world economy. The two economies are interdependent to a high degree. Close to a quarter of all EU-US trade consists of transactions within firms based on their investments on either side of the Atlantic.
The transatlantic relationship also defines the shape of the global economy as a whole as either the EU or the US is also the largest trade and investment partner for almost all other countries in the global economy. In 2008, total FDI stocks held in each others countries reach approximately €2.1 trillion. The overall “transatlantic workforce” is estimated at 12 to 14 million people, of which roughly half are Americans who owe their jobs directly or indirectly to EU companies.
The European Union and the United States have the largest bilateral trade relationship in the world.
Trade in goods
* EU good exports to the US in 2009: €204.4 billion
* EU goods imports from the US in 2009: €159.8 billion
Trade in services
* EU services exports to the US 2009: €119.4 billion
* EU services imports from the US in 2009: €127.0 billion
Foreign Direct Investment
* EU investment flows to the US in 2008: €121.4 billion
* US investment flows to the EU in 2008: €50.5 billion
Yves here. Geithner’s optimism might be warranted if one believed the Eurozone upheaval was on its way to a happy resolution. But what is happening instead is:
1. Rather than take measures to allow for an internal rebalancing (such as more promoting more demand from Germany and the northern states, restructuring Greek debt), the EU has put itself on a deflationary path.
2. Given the fiscal straitjackets on member states, the only way to offset deflationary pressures is via currency depreciation, so that strengthening exports will buffer the impact of austerity measures. That is happening, with a vengeance.
3. Even with a sharp fall in the euro, deflation may still take hold, so sovereign defaults (realistically, restructurings) beyond Greece (which seems hopeless) are quite possible
4. A decline in the euro could set off competitive devaluations (at a minimum, my contacts in the UK expect the pound to need to keep pace with the euro, whether by happenstance or design). At a minimum, it will put a major crimp in US exports, dampening the US recovery (such that it is) and put pressure on China. If the loss of export-related jobs is great enough, it could lead to protectionist measures
5. A disorderly fall in the euro has and will continue to lead investors to shun risky assets. The shift in investor sentiment will stress a less than healthy financial system. We know what that movie looks like
And despite the attempt to convince his audience that the EU can go it alone, Geithner was awfully quick to defend IMF involvement:
Geithner also said a Republican proposal to bar U.S. support for IMF loans to European countries is “absolutely not” reasonable. “We have a big stake in helping Europe manage through these things,” he said. “We’re going to do it in a way that’s sensible for the American economy, the American taxpayer.” The U.S. holds a 17 percent stake in the IMF.
And Mr. Market does not agree with Geithner. I’ve pinged the author to see if I can reproduce the key charts here (please check back if you see “Updated” in the headline) from a report on Friday’s market action by the anonymous analyst who prepared a detailed report on the May 6 meltdown. Bottom line: through the early PM, the selling pressure on Friday was WORSE than on May 6. As long at the Eurodollar rate is elevated, investors are going to be cautious about taking on risky assets.