short-term interest rates cut

In post-WWII Europe, monetary policy has been dominated by institutional memories of the hyperinflation that plagued the Weimar Republic in the first quarter of the last century.  The hard lesson learned then, and being applied now?–eliminate any whiff of inflation, even at the expense of economic growth.

That’s been the mantra of the German Bundesbank and of its intellectual successor, the European Central Bank.  It’s why the ECB raised short-term interest rates in the wake of the subprime mortgage crisis rather than follow the lead of the Federal Reserve in the US and lower them to try to stimulate economic growth.

…until now, that is.

Two days after assuming his position as president of the ECB, Mario Draghi cut rates by .25% to 1.25%.  He cited the risks of recession and he played down any threat from inflation, which is currently running above the central bank’s target of 2%.

This is good news.  The positive stock market response to this move seems to me mostly a reading that the torch has been passed from the Bundesbank to a new generation of policymakers who will act more in the American mold–rather than to the rate decrease itself.  Again good news.

an ultimatum to Greece

It’s over a year since the Papandreou administration announced that the former Athens government had been falsifying the national accounts for years and that the country was in effect broke.  Bailout talks have dragged on almost interminably.

The Greek negotiating style, as I see it (sitting here in on the east coast of the US), is real hardball stuff and not designed to win either friends or continuing business relationships.  It consists of repeatedly leaving the table after giving the EU the impression that the parties have reached a “final” agreement–and then reopening talks to ask for further concessions a week or two later.

Many companies have told me that it’s commonplace in China to haggle even after formal contracts have been printed up.  I worked for someone who did this all the time.  The idea is to use the fact that the other side has already reported to its bosses that they have a deal as leverage to extract slightly better terms.  But like the death of a thousand cuts, this process goes through many iterations.  So the multiple “slightly betters” can add up to a lot.

In this case, there’s also the issue that a real default by Greece would hurt the EU more seriously than is commonly realized.  The EU wants a restructuring of Greek debt that won’t trigger many billions of euros of credit default swaps its banks have entered into.  To avoid punching another wide hole in the banks’ capital, the EU needs Greece to cooperate.  Greece has used this to its advantage.

Yesterday, however, the EU said enough is enough.  It halted negotiations once and for all.  It says that Greece must accept the latest restructuring package and implement the economic austerity measures that entails.  The EU also says it is starting to make preparations to expel Greece from the EU if it does not.

(In other words, it is figuring out how to prop up any EU banks that become insolvent, either from holding Greek sovereign debt or from foolish credit default swaps.)

This doesn’t mean Greece will finally accept the bailout package.  It may opt to default and be tossed out of the EU.  I doubt it, but I don’t know. At any rate, however, the EU has finally drawn a line in the sand and set a time limit.

The issue will be decided before yearend.  Uncertainty will be over.  Investors will be able to see and deal with the implications of what Greece elects to do.  That in itself is a positive.

investment implications

The one-day read by Wall Street is that both developments are plusses for world economic growth.  I agree.

In addition, investors appear to be thinking that the primary beneficiaries will be the most highly cyclical firms, like capital goods or basic materials companies.  I’m not sure that’s right.  I prefer consumer discretionary and IT stocks.  But I’ve got to keep an open mind, since the business cycle message is being delivered so strongly so far.