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Theory of Central Banking Rapidly Falling Apart

Currencies / Central Banks May 14, 2010 - 11:53 AM GMT

By: Mike_Shedlock


Best Financial Markets Analysis ArticleCentral banks are about to learn the global economy is not Alice's Restaurant.

In case you don't know the tune, here is the crucial line: "You can get anything you want at Alice's Restaurant"

Anything you want, seems to be the attitude of central banks. The problem is, it is virtually impossible for every central bank to get what it wants at the same time, when they all want the same thing, cheaper currency relative to each other to stimulate jobs and exports.

Here are a few examples to help explain what I mean.

UK at Mercy of Demand in EU

Please consider U.K. Trade Deficit Widened in March on Import Jump

The U.K. trade deficit widened in March as imports jumped the most in six months, led by demand for goods from cars to engineering equipment.

The Bank of England is counting on a weak pound to boost exports and support economic growth it helped manufacturing jump the most since 2002 last month. The sovereign debt crisis in Europe has darkened the outlook for U.K. exporters at a time when domestic demand may come under pressure from measures to tackle the public finances.

“With a fiscal squeeze looming, and set to have knock-on effects on consumer incomes, we think that the onus is still on the external sector to keep the recovery going,” Vicky Redwood, an economist at Capital Economics Ltd. and a former Bank of England official, said in a note. “Recent events in the euro zone -- the U.K.’s biggest trading partner -- clearly cast a shadow over the longer-term prospects for U.K. exporters.”

The U.K.’s trade deficit with the European Union widened to 3.4 billion pounds in March, a three-month high, from 2.9 billion pounds in February. Bank of England Governor Mervyn King yesterday cautioned that the U.K. economy remains vulnerable to the fiscal crisis in the euro area, its biggest trading partner.

King said that rebalancing the U.K. economy after the deepest recession on record relied on “a prosperous European economy.”

“We’re seeing a big, big increase in manufacturing,” Alan Clarke, an economist at BNP Paribas in London, said in a phone interview before the report. “It may be that at long last we have an improvement in external demand or are reaping the benefit of a weaker sterling. We’re at the mercy of demand in the euro zone.”

China’s Trade Surplus Shrinks 87%

Inquiring minds note China’s April Trade Surplus Shrinks 87% on Imports

China’s trade surplus shrank 87 percent in April from a year earlier as imports grew faster than exports because of stimulus-driven domestic demand.

A 79 percent decline in the trade surplus in the first four months of 2010 from a year earlier may ease pressure for gains in the yuan and support Premier Wen Jiabao’s argument that the currency isn’t undervalued. The sovereign-debt crisis in Europe that today prompted a loan package of almost $1 trillion to help nations under attack from speculators may also encourage Chinese officials to delay ending the yuan’s peg to the dollar.

Yuan gains would be “a disaster,” Song Zimin, an executive in the import and export department of apparel maker Shanghai Dragon Corp., said in an interview at China’s biggest trade fair in Guangzhou on May 3. “If the yuan rises 3 percent, where’s our profit? Many, many factories will close.”

Chinese President Hu Jintao told his U.S. counterpart Barack Obama last month that the nation will adjust currency policies according to its own need and won’t bow to foreign pressure. U.S. Treasury Secretary Timothy F. Geithner meets with Chinese Vice Premier Wang Qishan in Beijing on May 24-25 for the so-called Strategic and Economic Dialogue between the two nations.

India and Brazil have backed calls from the U.S. and Europe for a stronger yuan.

Europe is China's biggest export partner. Since China pegs to the US dollar, China's exports to Europe just got a lot more expensive following this mini-crash of the Euro. That is not what China wants at all.

India, Brazil, the US, Europe, and Japan all want the Yuan to rise.

Adding fat to the trade war fire, the US is threatening to label China a currency manipulator on the misguided notion that US exports will rise if the Renminbi (Yuan) rises.

Japan Wants the Yen to Sink

As noted in Equity Plunge Yen Connection; Reflections on Ponzi Markets and Program Trading, last week's equity meltdown all started with a sudden spike in the Yen.

In response, to the strengthening of the Yen, the Bank of Japan pumped 2 trillion Yen ($21.8 billion), into the banking system, triggering selling of the Yen.

ECB's Action to Save the Euro

In Europe, the ECB's plan to "save the Euro" consists of printing $1 trillion worth of Euros. Given that it is impossible to strengthen a currency by printing more of it, the real goal was not to save the "Euro" but to bail out European banks sitting on bad Greek debts.

Long term, the plan increases debt, exactly the wrong thing to do in a deflationary world.

Short term, that action spawned an unprecedented round trip move on the Euro vs. the US dollar from 1.27 to 1.31 and back in little over a day.

Bounce or Die for the Euro and British Pound

For charts and additional commentary on the Euro and British Pound, please see Bounce or Die for the Euro and British Pound?

Make no mistake about. Trichet wants a cheaper Euro to help European exports, even as the UK is at the mercy of demand in Eurozone countries.

To top it off, the US does not want a cheaper Euro or a stronger dollar out of fear of losing Boeing contracts to Airbus, and grain exports to Brazil and Australia.

In 2001-2002 Greenspan thought slashing interest rates and printing money was a free lunch. Instead, it spawned the biggest real estate/debt bubble the world has ever seen. For a while, Greenspan's efforts created jobs. Then came the global bust. The debt still remains, the jobs didn't.

Now the EU has adopted the same nonsensical plan. Yet all the EU has accomplished is to increase the amount of debt that cannot be paid back. Trichet needs a clue, and here it is: You cannot fight deflation by taking on more debt. Here's a second clue: central banks can print, but they cannot dictate where the money goes.

The housing bubble collapsed years ago, but the global central banker fight against deflation still remains, with one big beneficiary: Gold.

Gold Monthly Chart

Amazingly, until this crisis started last week, there was near unanimous opinion that the US dollar needed to sink and for the Yen, Yuan, Pound, and Euro to strengthen.

"Near Unanimous" is the opportune phrase because Japan wanted the Yuan to rise but not the Yen, and China was just happy with the status quo.

If that is not one totally *upped daisy chain of impossible Central Banker wants and needs, what is?

Hello Ben Bernanke, Jean-Claude Trichet, and Mervyn King, this is Alice, and you are in Wonderland, not my restaurant. At Alice's there is no free lunch. We only take gold.

By Mike "Mish" Shedlock

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Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at .

© 2010 Mike Shedlock, All Rights Reserved.

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