Monday, August 6, 2012

Irreversible Euro

During the ECB press conference last Thursday August 2nd, Mario Draghi, the President of the ECB, mentioned that the Euro is 'irreversible'. A media reporter asked him what did he mean when he said 'irreversible'? Mario spoke in a firm and clear tone, "when I said irreversible it means Euro can never go back to lira or drachma, it is here to stay for ever!"

Through out the whole Q&A session, he answered many questions on bond purchase and financial aids for the Eurozone, but it is nothing compared to the above statement about Euro dollar sent a very strong signal that whoever think Euro is going to collapse, will need to think twice!

The next day, DJI soared 2% and subsequently other Asian markets rebounded on Monday. Whether this rally genuine or not depends on the following factors:

- Corporate earnings - As we've come to the earnings season in August, what drives the market very much depends on the individual corporate earnings. If economies are recovering, we should see better corporate earnings.

- Economic data - GDP figures from the major countries such as the Eurozone, US, and China will indicate the financial health of the economies that in turn affect the stock markets. So far these figures have been weak, confirming economic slow down globally.

- Government effort - So far since the financial crisis in 2008, governments around the world are the true followers of the Keynesian philosophy, not only that, they went beyond it - they use the last resort of printing money to finance their fiscal stimulus! And amazingly, prices for these money printing countries have been able to keep low. Does that sound like the lost decade- Japan? Remember, inflation arises when people are spending, or when too much money chasing too few goods. Obviously that did not happen or may be not yet because the consumer and business confidence are still weak.

In the end, these governments who spent huge stimulus to artificially shore up the economy will need to reconsider this option. They need to think about these questions:

1. If interest rates are already low, how can we further stimulate the economy with monetary policy?

2. If monetary policy is not working, can we use fiscal policy to stimulate the economy?

3. Then the next question is: How do we finance the additional fiscal spending? By borrowing more money (debt level already high) or by printing more money? Borrowing more money will lead to higher debt level which jeopardise the valuation of the currency and credit rating. How about printing money? Firstly, printing money is inflationary. In addition, printing money will lead to inflationary asset bubble and the depreciation of the currency as well.

Since in the periods of recession, monetary policy generally doesn't work well, the best measure is still fiscal policy. But this has to be finance within your means, and make sure allocation of funds is towards the improvement of labour skills and the efficiency (or productivity) of the work force, rather than constructing white elephants projects or spending money on unnecessary infrastructures that do not drive long term growth for the economy.

Below is the chart of the S&P which shows an ascending triangle is forming, if S&P could break 1400 level, there is a high chance of reaching the next target level of 1500.

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