UKRAINE - The Unfolding Financial Battle

ECB - EU Version of QE Coming -> UST Purchases To Drive Euro Down

Considering QE, Mario? Buy US bonds, not Eurobonds 03-24-14 Jeffrey Frankel

The Eurozone needs to further ease monetary policy because under the current low inflation and high unemployment periphery countries need to suffer painful deflation. However, the ECB faces challenges other central banks do not face. This column proposes a way to overcome some of these hurdles. It argues that the ECB should buy US treasury securities, lowering the foreign exchange value of the euro. That would be the best way to restore the export sector of the periphery countries.

The ECB should further ease monetary policy. Inflation at 0.8% across the Eurozone is below the target of ‘close to 2%’, and unemployment in most countries is still high. Under the current conditions, it is hard for the periphery countries to bring their costs the rest of the way back down to internationally competitive levels as they need to do. If inflation is below 1% Eurozone-wide, then the periphery countries have to suffer painful deflation.

The question is how the ECB can ease, since short-term interest rates are already close to zero. Most of the talk in Europe is around proposals for the ECB to undertake Quantitative Easing (QE), following the path of the Fed and the Bank of Japan, expanding the money supply by buying the government bonds of member countries. This would be a realization of Mario Draghi’s idea of Outright Monetary Transactions (OMT), announced in August 2012, but which never had to be used (De Grauwe and Ji 2013).

QE would present a problem for the ECB that the Fed and other central banks do not face. The Eurozone has no centrally issued and traded Eurobond that the central bank could buy (and the time to create such a bond has not yet come, see Frankel 2012). That would mean that the ECB would have to buy bonds of member countries, which in turn means taking implicit positions on the creditworthiness of their individual finances. Germans tend to feel that ECB’s purchase of bonds issued by Greece and other periphery countries constitutes monetary financing of profligate governments and violates the laws under which the ECB was established. The German Constitutional Court believes that OMTs would exceed the ECBs mandate, though last month it temporarily handed the hot potato to the European Court of Justice. The legal obstacle is not merely an inconvenience but also represents a valid economic concern with the moral hazard that ECB bailouts present for members’ fiscal policies in the long term. That moral hazard was among the origins of the Greek crisis in the first place (Frankel 2011).

Fortunately, interest rates on the debt of Greece and other periphery countries have come down a lot over the last two years. Since he took the helm at the ECB, Mario Draghi has brilliantly walked the fine line required for ‘doing what it takes’ to keep the Eurozone together (After all, there would be little point in preserving pristine principles in the Eurozone if the result were that it broke up. And fiscal austerity was never going to put the periphery countries back on sustainable debt paths). At the moment, there is no need to support periphery bonds, especially if it would flirt with unconstitutionality.

What, then, should the ECB buy, if it is to expand the monetary base? It should not buy euro securities, but rather US treasury securities. In other words, it should go back to intervening in the foreign exchange market. Here are several reasons why.

• First, it solves the problem of what to buy without raising legal obstacles. Operations in the foreign exchange market are well within the remit of the ECB.
• Second, they also do not pose moral hazard issues (unless one thinks of the long-term moral hazard that the ‘exorbitant privilege’ of printing the world’s international currency creates for US fiscal policy).
• Third, ECB purchases of dollars would help push the foreign exchange value of the euro down against the dollar.

Such foreign exchange operations among G7 central banks have fallen into disuse in recent years, in part because of the theory that they don’t affect exchange rates except when they change money supplies (Fratzscher 2004, Dominguez and Frankel 1993a, 1993b). There is some evidence that even sterilized intervention can be effective, including for the euro (Sarno and Taylor 2001, Reitz and Taylor 2008, Taylor 2004, Fatum and Hutchinson 2002). But in any case, we are talking about an ECB purchase of dollars that would change the euro money supply. The increased supply of euros would lower their foreign exchange value.

Monetary expansion that depreciates the currency is effective. It is more effective than monetary expansion that does not, especially when, as at present, there is very little scope for pushing short-term interest rates much lower.

Depreciation of the euro would be the best medicine for restoring international price competitiveness to the periphery countries and bringing their export sectors back to health. Of course, they would devalue on their own if they had not given up their currencies for the euro ten years before the crisis (and if it were not for their euro-denominated debt). Euro depreciation is the answer.

The strength of the euro has held up remarkably during the four years of crisis. Indeed, the currency appreciated further when the ECB declined to undertake any monetary stimulus at its March 6 meeting. The euro could afford to weaken substantially. Even Germans might warm up to easy money if it meant more exports rather than less.

Central banks should – and do – choose their monetary policies primarily to serve the interests of their own economies. The interests of those who live in other parts of the world come second. But proposals to coordinate policies internationally for mutual benefit are fair. Raghuram Rajan, head of the Reserve Bank of India, has recently called for the central banks in industrialized countries to take the interests of emerging markets into account by coordinating internationally.

How would ECB foreign exchange intervention fare by the lights of G20 cooperation? Very well. This year the emerging markets are worried about tightening of global monetary policy. The fears are no longer monetary loosening as in the ‘currency wars’ talk of three years ago. As the Fed tapers back on its purchases of US treasury securities, it is a perfect time for the ECB to step in, and buy some itself.

ECB - EU Version of QE Coming -> UST Purchases To Drive Euro Down

PETRODOLLAR - Pins Being Setup for a Collapse

Russia Prepares Mega-Deal With India After Locking Up China With "Holy Grail" Gas Deal 03-24-14 Zero Hedge

Last week we reported that while the West was busy alienating Russia in every diplomatic way possible, without of course exposing its crushing overreliance on Russian energy exports to keep European industries alive, Russia was just as busy cementing its ties with China, in this case courtesy of Europe's most important company, Gazprom, which is preparing to announce the completion of a "holy grail" natural gas supply deal to Beijing. We also noted the following: "And as if pushing Russia into the warm embrace of the world's most populous nation was not enough, there is also the second most populated country in the world, India." Today we learn just how prescient this particular comment also was, when Reuters reported that Rosneft, theworld's top listed oil producer by output, may join forces with Indian state-run Oil and Natural Gas Corp to supply oil to India over the long term, the Russian state-controlled company said on Tuesday.

Rosneft CEO Igor Sechin, an ally of President Vladimir Putin, travelled to India on Sunday, part of a wider Asian trip to shore up ties with eastern allies at a time when Moscow is being shunned by the West over its annexation of Crimea.

With EU nations threatening to cut their reliance on Russian oil and gas, Russian officials have started to look East.

Rosneft said it had also agreed with ONGC they may join forces in Rosneft's yet-to-be built liquefied natural gas plant in the far east of Russia to the benefit of Indian consumers.

We just have one question: will payment for crude and LNG be made in Rubles or Rupees? Or in gold. Because it certainly won't be in dollars.

Rosneft, which is increasing oil flows to Asia to diversify away from Europe, did not provide any additional details but said it had discussed potential cooperation with Reliance Industries and Indian Oil.

It did not have to: it is quite clear what is going on. While the US is bumbling every possible foreign policy move in Ukraine (and how could it not with John Kerry at the helm), and certainly in the middle east, where it is alienating Israel and Saudi just to get closer to Iran, Russia is aggressively cementing the next, biggest (certainly in terms of population and natural resources), and most important New Normal geopolitical Eurasian axis: China - Russia - India.

More:

The company said Sechin and the head of Indian conglomerate Reliance Industries also met and discussed potential cooperation in developing Russia's offshore resources, viewed by Moscow as a source of future oil production growth.

India was the last country in Sechin's Asian trip, where he also visited Japan, South Korea and Vietnam.

Russia is the world's top oil producer, pumping over 10 million barrels per day but mostly from west Siberian deposits, which are running out. Moscow is betting on offshore and unconventional oil to maintain the level.

At the same time, Russia is trying to diversify its energy flows away from its core European markets, with Rosneft leading the race with plans to triple oil flows to China to over 1 million barrels per day in coming years.

Rosneft said Sechin also discussed potential shipments of Russia's East Siberia-Pacific Ocean (ESPO) oil blend to India's biggest refiner Indian Oil Corporation (IOC.NS) but did not provide details.

There is only one country missing - Germany. Because while diplomatically Germany is ideologically as close to the US as can be, its economy is far more reliant on China and Russia, something the two nations realize all too well.  The second the German industrialists make it clear they are shifting their allegiance to the Eurasian Axis and away from the Group of 6 (ex Germany) most insolvent countries in the world, that will be the moment the days of the current reserve petrocurrency will be numbered.

RISK -Risk Being Withdrawn

PATTERNS - Russell Medium PE on 5 Yr Normalized EPS

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GLOBAL RISK - Fractured Saudi Relationship Imperils Petro$$ Strategy

The Hydraulic Fracturing of Saudi Arabia... 03-23-14 L Todd Wood via ZH

Since the early twentieth century, Saudi Arabia has enjoyed a close relationship with the United States. From the development of the Saudi oil fields,to the First Gulf War, this relationship has been an uneasy cooperation—each side received something out of the alliance while nervously watching the other.  So recently we have the first open break between the two powers culminating in the Saudi’s refusing a seat on the U.N Security Council due to anger with U.S. Middle Eastern policies. 

Saudi Arabia holds the world’s second largest oil reserves and the sixth largest natural gas fields.  In addition to being located in the most volatile part of the world, these energy assets make the country a strategic interest for any global power. 

The discovery of vast hydrocarbon reserves in the United States and the ability to harvest them through hydraulic fracturing techniques has radically altered the relationship between the two countries.  Ironically, even though the Obama administration has reduced drilling on Federal lands in the US and attempted to curtail hydrocarbon use overall, it is fracking which has allowed the United States to nearly gain energy independence, become a net energy exporter again, and reduced the need to buy oil from the Middle East.  This shift in the balance of power with the Saudis has made the Kingdom extremely nervous. 

American policy adds to the Saudi’s concerns.  The Saudi oil fields, located in the eastern part of the country, are the home to the country’s Shia minority.  As the guardians of the holy Muslim sites, the royal family walks a fine line between satisfying the Sunni Ulema, fighting terrorism, and keeping the Shia population in check.  Hence, their concern with America’s recent overtures to Iran. 

The Obama administration has been Hell bent to secure a deal with the Shia Islamist state regarding its development of nuclear weapons.  Now that the deal is in place, the Iranians are openly taunting the West with shouts of victory rather than assuring the world they have no intent to join the nuclear club.   John Kerry and his Dept of State have been either naive, weak, or both when it comes to negotiating with the mullahs.  The Saudis, along with the Israelis and other Gulf states, cannot tolerate a nuclear armed Iran.  There are rumors that Saudi Arabia has paid Pakistan for the development of its own nuclear deterrent and is one month away from operational capability if they saw fit. 

In addition, the Kingdom is furious with U.S. refusal to arm Sunni rebels fighting the Iranian backed Syrian regime.  The uneasy trust between the U.S. and Saudi Arabia has been broken.  This opens up the playing field for other global powers such a China or Russia to make inroads where the U.S. once enjoyed hegemony.  It also opens up the world to a possible nuclear arms race in the Middle East.  In fact, this is already happening in Egypt, another broken U.S. relationship, who just closed a major arms deal with Russia in a slap in the face to the Obama Administration’s decision to cut military aid.  China would like nothing better than to gain access to a secure source of Saudi oil and strategic American built bases as well.

There have been calls from many quarters for the U.S. to mend fences with Iran in order to prevent a conflict and counter the Sunni influence in the region.  It seems obvious that for this to happen, Iran needs to show real progress in addressing the world’s fear that they intend on acquiring the bomb and have plans to use this threat to destroy Israel and/or the interests of the United States.    But alas, this will probably not happen with the current Iranian government.

It is foolish for America to offend and promote distrust with another ally in a long list of broken long-standing relationships.  These include Poland, United Kingdom, Israel, Egypt, etc.  One wonders whether the results of American diplomacy  stems from extreme incompetence or is evidence of a much darker agenda

GLOBAL PETRODOLLAR - EU Energy Dependency Stands Out

RESERVE CURRENCY - Yuan as A Third 'Balancing" Reserve Currency

Russia Returns Favor, Sees Chinese Yuan As World Reserve Currency 03-24-14 Zero Hedge

Following China's unwillingness to vote against Russia at the UN and yesterday's news that China will sue Ukraine for $3bn loan repayment, it seems Russia is returning the favor.

Speaking at the Chinese Economic Development Forum, ITAR-TASS reports, the Chief Economist of Russia's largest bank stated that "China's Yuan may become the third reserve currency in the in the future."

Managing Director and Chief Economist of investment company Sberbank Yevgeny Gavrilenkov said at the 15th governmental Chinese economic development forum in the Chinese capital on Sunday (via ITAR-TASS):

"China’s yuan (renminbi) may become a third reserve currency in the world in the future"

"This forecast can be made on figures of domestic economic growth. Probably the country will keep high GDP growth rate and the GDP volume will increase to around 14-16 trillion U.S. dollars for a brief period of time, the indicators comparable to the European Union and the United States.

Meanwhile, Chinese securities are more attractive for the countries that have a surplus in economy, particularly the Middle East states; and China will obviously follow the path of securing the country’s assets,"

The forum which opened in the Chinese capital on March 22 discusses a broad range of issues of economic reforms and China’s stronger role as the second largest world economy. First Deputy Prime Minister of the Chinese State Council Zhang Gaoli, Managing Director of the International Monetary Fund Christine Lagarde and top managers of major world corporations participate in the forum as honorary guests.

Of course, as we noted previously, nothing lasts forever...

and with Friday's "Petrodollar Alert" perhaps things are moving faster than many assumed.

Why Putin Is Able To Screw With The US At Every Turn 03-21-14 BI

With respect to the crisis in Ukraine, the Obama administration has struggled to respond on the fly and calibrate a strategy that sends a clear message to Russia while keeping in mind the necessity to keep Putin as a diplomatic partner.

This is where Putin's greatest leverage lies in Ukraine. The U.S. needs him as a partner to complete major objectives with regard to Iran nuclear talks, the Syrian war, and negotiations between Israel and Palestine.

"Everyone wants to avoid confrontation with Putin, pretend he’s an ally or at least that he can be worked with," Garry Kasparov — a former grand chess master and loud critic of Putin and the Obama administration's strategy toward Russia — told Business Insider. "This has always been a myth, and now everyone is finally realizing what a dangerous myth it was."

The crises are blending some of the thorniest issues of President Obama's second term. On Wednesday, Russia Deputy Foreign Minister Sergei Ryabkov warned the U.S. of the consequences of further sanctions, saying it could recalibrate its position on Iran.

The administration has not been deterred in imposing further punitive measures on Russia, as Obama announced new sanctions on 20 Russian officials and other individuals on Thursday, as well as one "crony" bank. Russia took notice, and the sanctions had a noticeable first-day effect on markets.

Senior Obama administration officials signaled Thursday they believe Russia is bluffing over its Iran threat. But it was also clear from a conference call with these officials that there's no contingency plan if Russia is serious.

"We will evaluate Russian actions. We take note of their words, but we have not seen a change in the P5-plus-1," one senior U.S. official said, referring to the group of the six world powers. "Now, that may not stay the same. They may act on the words of the deputy foreign minister yesterday. But all we can say is what we’ve seen to date, which is the P5-plus-1 is continuing a regular rhythm of political directors meetings and technical expert meetings."

The official didn't answer follow-up questions asking for a direct response to Ryabkov's comments, which cannot be taken lightly. Already in January, Iran and Russia moved toward a significant deal that would allow Iran to lift oil exports in defiance of Western sanctions. 

“If you’re Putin and you think you’re going to be a target of sanctions, the most obvious leverage is in the Iranian file, where Russian cooperation is so important,” Mark Dubowitz, the executive director of the Foundation for Defense of Democracies, told The New York Times.

A Russian shift in position on Iran, after months of cooperation, would dramatically deteriorate the possibility of a diplomatic end to the issue.

Moscow provided an alternative, jumping on an offhanded comment by John Kerry. The subsequent process of removing Syria's chemical weapons has been full of missed and extended deadlines, while Syrian President Bashar Assad's forces continue to bomb Syrian civilians into oblivion with Russian weapons.

Why did the U.S. abandon its original plan to strike Assad? Much of it had to do with the fact that it needed Russia as a crucial partner in Iran nuclear talks.

Now, Moscow-Washington relations are crumbling, while Assad takes advantage of the Ukraine crisis to crush the rebellion to his rule. And Putin's continued support of ousted President Viktor Yanukovych has reinforced to Assad that Putin will protect his interests in Syria.

Basically, the "Russian reset" policy of engaging the Kremlin to pursue shared goals "has been a serious foreign policy failure for the Obama administration," Ian Bremmer, president of Eurasia Group, told Business Insider.

It's not clear whether Russia will carry out its threat on Iran — after all, it also has interest in a comprehensive deal. It doesn't want a war in its backyard and, as one U.S. official said, if Iran develops a nuclear weapon it would be "whole lot closer to Russia" than the U.S.

But in the weeks to come, the U.S. will clearly be walking on a fine line as several of the world's most pressing geopolitical problems become increasingly intertwined.

"On Ukraine, again, I am confident that we will all approach this negotiation to get our work done and our job done," one official coming out of the latest Iran talks told reporters Tuesday.

"And I continue to hope that ongoing events in Ukraine and actions that may be taken will not change that. But I can't tell you today for a certainty that that will be the case, because all of the events happening in the world are not under our control."

HOUSING - Double Top in Construction Index

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PETRODOLLAR - Russian Gas Strategy

Russia's Energy Sector Evolves 09-27-13 Stratfor

PETRODOLLAR - Russian Gas Strategy

Russia Tries to Crack China's Natural Gas Market 09-11-13 Stratfor

PETRODOLLAR - Russian Gas Strategy

Russia's Competition for Natural Gas Deals with China 09-12-14 Strafor

SENTIMENT - Setting Up for Sentiment Change