When Did the Game Change?

Did you see that? A few days ago, Europe, the Euro and European sovereign debt problems were pulling markets down. Thank goodness the US was coming to the rescue with its strong dollar. But in a blink after the TV channels were were changed from the FIFA World Cup, we find that Europe looks OK, but the US is falling apart! Are you kidding? What happened over the weekend?

Like we said in an earlier post, the Euro was looking bad only when it was playing catchup in the downward currency slide already led by the US dollar. Suddenly, northern European competitiveness is looking vastly enhanced. Europe was apparently not only talking tough fiscally but looked like it might actually do something about it.

Rather inconveniently, figures confirmed that the typical American consumer is absolutely mired in a negative personal balance sheet disaster, but also that employment - already officially overstated - was plunging no matter what rosy spin was put on the numbers. The combination is utterly toxic and short of faith-based economics, is beyond structural fixing in the near term.

The European central banks are only charged with keeping inflation under control. The US Fed has the extra official burden of maintaining employment. Congress wants both but jobs talk loudest. What they say is 'this time is special, so roll the presses'. Did I mention that the US wants to wind down its military presence overseas but at the moment the are no extra jobs waiting, as was promised, for returnees?

That's one side of the dilemma. The other is that China now owns one-half of the US external debt and makes the stuff that US consumers want to spend their not so available money on. If money is relatively unavailable, that would make rates go up, right? Interest rates must be held down at home or the time bomb of external American interest payments will blow everything else it tries to do out of the water. Never mind entitlement expenditures. Interest rates are the 800-pound gorilla that's too scary to talk about.

We are now entering an end-game period when the curtain will be lifted on just how much the US dollar, the world's reserve currency, is going to have to be inflated to keep Americans working at the same time as it attempts to diminish the external value of American debt repayment. The Japanese have a huge debt to GDP ratio. The thing about Japanese debt is that, by far, most of it is owned in Japan. So, other people's currencies getting stronger; official reserve currency getting weaker. Expect international rhetoric and protests to get very strident and hope for nothing worse.

For the Fed to fix that one painlessly, the trick will be to shift the pain elsewhere. Elsewhere may not be happy at the prospect.