Chart of the Day: US Stock Performance in September 2010 Not the Best Since 1939

Over the past few days, I have heard from a number of stock market analysts say that this past September’s rally in the S&P500 was the best performance since at least 1939. That’s 71 years! This afternoon, I heard an analyst describing why the market was up so much. She said it is because earnings have been so good and they will continue to be. But, there is another reason: the US dollar and the beggar thy neighbour politics of competitive currency devaluation.

Back in April, when the euro zone was falling apart because of the Greek sovereign debt crisis, the common wisdom was that the euro would go straight to parity with the dollar as the problems mounted and the ECB started buying up sovereign debt. I said there were two scenarios to alleviate the Greek crisis.

In scenario one, you eject Greece from the Eurozone, they devalue their currency and, after a turbulent period, they are on the road to recovery.  The problem, of course, is that it’s on to the next Euro debtor, Portugal.  Do they then get ejected too?  Next stop, Spain. And then Italy. Marshall says that France, in particular, would face a serious problem with competitiveness in such a scenario. As I recall, France is a founding member of the so-called Club Med southern European Eurozone countries. This is not a good outcome for France. And it is certainly not a good one for the European banks which hold the sovereign debt of countries like Greece, which has the largest external sovereign debt-to-GDP ratio in the world.

Outcome number two is to depreciate the Euro, of course. The Euro is dropping as we speak.  But, I am talking about a more serious decline. As I recall, the Euro dipped to as low as 83 cents during Robert Rubin’s strong dollar policy days.  If the EU structures the bailout in the right way (fully backstops the period of increasing debt to to GDP) and floods each country with liquidity (aka prints money), you are sure to get this kind of outcome. Everyone gets a massive boost to competitiveness. Problem solved.

However, the Germans would never go along with this ‘weak currency’ strategy.  Moreover, the Americans would cry bloody murder because this is a competitive currency devaluation of the entire Eurozone.

Twenty-first century competitive currency devaluations

The Europeans have gone with scenario number one to date. But, then the U.S. became worried about its own ability to compete against a weak euro. U.S. data started to get soft and the talk turned to quantitative easing – which is now considered pretty much a lock for the Nov 3rd Fed meeting. The result has been a real fall in the dollar against pretty much every major currency.

The following two charts on U.S. August stock returns gives you a sense of this (hat tip Alberto Artero). In chart #1 you see the monster 71-year best for the S&P 500.


But if you take the same S&P rally in Euros, the chart looks like this:



Decidedly unspectacular. If the Federal Reserve goes QE, it could get much worse for the euro zone (not to mention Brazil, Japan, Australia, Switzerland, Sweden and a host of others).

Remember Brazilian Finance Minister Mantega’s remarks last week?

Mr Mantega, who has made increasingly aggressive comments recently about the need to control Brazil’s currency, said governments around the world were trying to weaken their currencies to promote competitiveness.

“We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness,” he said, according to Reuters.

The US dollar has fallen by about 25 per cent against the real since the beginning of last year, making the real the strongest performing currency in the world, according to Bloomberg.

So now we have a situation in which the Euro is back to where it was when it first began to drop – and it is overvalued on purchasing power parity basis at that level. This is excruciating for the likes of Portugal, Greece, Spain and Ireland, now undergoing austerity.

As a result of austerity, Greece, Ireland and Spain are all back in recession. Niels Jensen has this right when he says:

Fiscal austerity means lower economic activity, unless you can lever up the private sector (not likely given the current level of private sector leverage) or you can improve the current account; however, we cannot all export our way out of our problems – somebody will have to do the imports.

The lower economic activity will again lead to lower tax revenues for the public sector; it is a very unfortunate and rather unpleasant vicious spiral which, by the way, is also very deflationary. The chances of inflation rearing its ugly head anytime soon in Europe (with the possible exception of the UK) are extremely remote unless the euro is abolished, in which case governments across Southern Europe will be tempted to inflate their way out of current problems. But that is a story for another day.

Europe will want to respond and depreciate in turn – as will everyone else.

Source: ¿De verdad ha subido tanto la Bolsa en septiembre? – Cotizalia

  1. Eparhiala says

    all you ever here in these bail out plans is “is good for the banks?” What about the country as a whole and all of it’s citizens? If it were not for the banks, and all the collaterization going on, then there would not be this problem to begin with.

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