Jim, are you talking your BRIC book?

Key News

  • Fed Chairman Bernanke warned that the Fed "does not want to be providing USD swaps as a permanent service for financial markets." (Reuters)
  • Note: Counterparty risk is rising and liquidity is falling among banks in Europe, as expected. Below is the spread between three month libor and overnight indexed swaps (3-mo).

    To give some perspective on this spread, the chart below includes the credit-crunch blowout period:

  • South Africa’s inflation rate fell to 4.8 percent in April, the lowest in almost four years. (Bloomberg)

Quotable

“A liberal is someone who feels a great debt to his fellow man, which debt he proposes to pay off with your money.”

                           G. Gordon Liddy

FX Trading – Jim, are you talking your BRIC book?

Talk about talking your book! I read this in the Financial Times this morning:

“Jim O’Neil of Goldman Sachs says policy crisis in the eurozone is unlikely to be a source of global financial market contagion. ‘Nearly 70 per cent of the eurozone economy is made up of three countries—France, Germany and Italy—and unless sovereign debt crisis derails their economies, it is tough to see how the eurozone could weaken sufficiently.’”

Question: Jim; did you recently get hit by a BRIC upside your head? Or maybe the question should be: How do you define contagion? Jeez Louise!

Where does one even begin with that type inanity, from a person who is far from inane? Yo Jim! Germany, that little country holding it all together over there; well, they send about 50% of their exports to the eurozone each year. If demand craters precisely because austerity works, staving off sovereign default, Germany will have to find some other customers very fast. Danger Will Robinson, danger! Back to short-term Treasuries and gold!

And here is why I think this is a man talking his book. As Germany heads off in search of greater demand for its exports, it bumps up against the BRIC among BRICS—China; a country who we know is still desperately seeking places for exports now that it’s leveraged its manufacturing capacity to the hilt. China would be hit hard if eurozone demand falls drastically thanks to austerity.

The Japanese, kind of a big exporter in the world, also rely heavily on eurozone consumption of their goods. And by the way, US companies tend to sell a lot to the eurozone too.

So it begs the question: If the glue that is holding together the eurozone—Germany–can’t find a suitable home for its goods to replace the demand it is losing on its continent, how long will they continue to prop up the euro welfare system when their incentives are nil, at best, and likely slipping into negative territory given the growing political backlash among German taxpayers? Thus, should Germany shrug, you can bet there will be major contagion in the world.

Martin Wolf of the Financial Times has done an excellent job over the last several months pointing out there must be balance in the world, i.e. if deficit countries cut deficits, demand for exports fades for now-surplus countries. Demand must come from somewhere, and if no one is willing to change their export model (read China and Germany), in a big way, there will be major tensions in the global economy despite the attempts by governments to soothe over this reality by wasting trillions of dollars of our money. [Note: That was my summary of Mr. Wolfe; he of course states it much more eloquently than I ever could.]

So, Mr. O’Neil, I beg to differ. But then again, maybe I’m just talking my book.