Tim Geithner and European Bloodletting

Stephen Fidler, the Wall Street Journal Brussels Chief, has a post today on the European attitude towards Tim Geithner's visits to the U.K. and Germany next Wednesday and Thursday, respectively.

The situation is this: even with the nearly $1 trillion "Euro TARP", as it's being hailed, the market is telling us that the European debit crisis is unresolved. And the reason is that both the math and political calculus suggest a Greek default, and possibly further European debt "restructuring", is inevitable.

With regards to whether the U.S. desires a strong or weak Euro, Mr. Fidler states "But where do U.S. interests really lie? Surely more in a strong euro than a weak one. A weak euro equates with a strong dollar which runs counter to U.S. efforts to power its economy by boosting exports and keep its current account deficit in check."

True, but surely that's not the whole story.


The big winner in the fall of the Euro has been the U.S. dollar, of course. Correspondingly U.S. treasury debt has also benefitted. And those results have all sorts of benefits for the U.S.

A weak Euro lends support to an overextended U.S. and its debt problem. Treasuries and the U.S. dollar become the "least bad" choice by default. This could aid the U.S. in its effort to further shift its debt burden to later years by refinancing shorter-maturity treasuries (less than 10 years) with longer-maturity treasuries (greater than 10 years). The temptation to do this must be very strong as yields on long-term treasuries have fallen recently from 4% to around 3.25%. This drop in long-term yields has led to record low mortgage rates in the U.S., which may in turn provide a boost to our ailing housing market.

Note that the British Pound has also been rallying against the Euro, although not as strongly as the U.S. dollar.

There is, however, a real risk to the stock market if the European debt crisis drags on unresolved. And a large decline in the stock market to March 2009 levels or lower would deal a severe blow to confidence, thereby jeopardizing the recovery.

It is for that reason that I believe the main purpose of Tim Geithner's trip is to encourage some European bloodletting. Geither's message to the Europeans is that the markets will not move onwards and upwards until the inevitable debt restructuring takes place. Everyone - Europe, the U.S., etc. all have a stake in maintaining the fragile confidence that had been gathering momentum in the global marketplace since March 2009.

The U.S. has a couple powerful chips to play as it encourages European debt restructuring. U.S. banks hold significant interests in European banks. And as part of Euro TARP, the Federal Reserve reopened its swap window with the European Central Bank. The U.S. Treasury and Federal Reserve don't always work hand-in-hand, and given the consequences the closing of the Federal Reserve window would have to be considered the "nuclear" option and not really on the table.

Will the Europeans blow off Geithner and go about their business as slowly as they want? It seems that the only trigger for European action has been the threat of the markets' "wolf pack".

Next week should be interesting.