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Monday, January 10, 2011 12:26 AM

Brazil Accuses US, China of Currency Manipulation; Intense Monetary Tightening in China; Iceland Solution Tempts Ireland;Unprecedented Hell in Belgium

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Here are a few of the many stories I am following: The risk of trade wars escalates as Brazil accuses the United States and China of currency manipulation. In turn, the IMF is upset at Brazil for imposing capital controls. In Belgium, the king wants to end the "unprecedented hell" that has left Belgium without a government for 211 days smack in the midst of a budget crisis. China is set for multiple rounds of credit tightening even though China's growth is weakening. Interest rates in Portugal and Spain suggest more bailouts coming up. Ireland is pondering the Iceland Solution and that has the IMF more than a bit upset.

Brazil Finance Minister Warns of Trade Wars

The Financial Times reports Brazil Warns Trade War Looming

Brazil has warned that the world is on course for a full-blown “trade war” as it stepped up its rhetoric against exchange rate manipulation.

Guido Mantega, finance minister, told the Financial Times that Brazil was preparing new measures to prevent further appreciation of its currency, the real, and would raise the issue of exchange-rate manipulation at the World Trade Organisation and other global bodies. He said the US and China were among the worst offenders.

“This is a currency war that is turning into a trade war,” Mr Mantega said in his first exclusive interview since Dilma Rousseff, Brazil’s new president, took office on January 1. His comments follow interventions in currency markets by Brazil, Chile and Peru last week and recent sharp rises in the Australian dollar, the Swiss franc and other currencies amid an exodus of investment from the sluggish economies of the US and Europe.
Tensions Rise in Currency Wars

In related news, the IMF is arguing against Brazil's imposition of capital controls as Tensions rise in currency wars.
If the world’s shell-shocked investors thought that 2011 might see an outbreak of peace in the currency wars, they were sadly mistaken. Not only did Brazil last week take more action to stem the rise in the real but Chile, one of the most free-market of emerging economies, has also unveiled a campaign of intervention against its currency.

With a sense that the battles against destabilising capital inflows are here to stay has come a determination to set new rules of engagement on controlling them. But given the uncertainty and political explosiveness around the issue, any such venture faces a tough future.

The International Monetary Fund last week revealed an attempt to put itself at the centre of the debate, releasing a study arguing for global rules to constrain governments’ use of capital controls. But observers doubt that it will broker a deal soon. “The IMF has made a pre-emptive grab for power without a clear idea of what it is asking for,” says Eswar Prasad, a former senior IMF official now at Cornell University.

The case for global rules is that one country’s actions can spill over to others. Last year’s rash of direct currency market intervention to slow speculative capital inflows, for example, proved self-perpetuating as country after country rushed to stop its own exchange rate being the only one to rise.
China's Trade Surplus Weakens

The New York Times reports China’s December Trade Rises, but Growth Weakens
China's December exports rose by double digits, possibly fueling tension with Washington ahead of Chinese President Hu Jintao's U.S. visit next week.

Exports rose 17.9 percent, producing a $13.1 billion trade surplus, though growth was down from November's 34.9 percent surge, customs data showed Monday. Imports gained 25.6 percent over a year earlier, down from the previous month's 37.7 percent growth but reflecting China's relatively strong economic growth.

December exports of $154.1 billion might be the highest monthly level ever for China, which overtook Germany in 2009 as the world's biggest exporter, according to Cohen.

Imports were $141 billion. The trade surplus was the third-lowest monthly level in 2010 and down sharply from November's $22.9 billion.

Beijing promised more exchange rate flexibility in June and the yuan has risen by about 3.5 percent against the U.S. dollar since then. Analysts expect the currency to rise by about 5 percent this year, but that is too little for critics who say the yuan is undervalued by up to 40 percent.

Beijing also faces criticism that it is hampering access to its finance industries and is improperly supporting its fledgling producers of solar, wind and other renewable energy technology by shutting foreign suppliers out of government-financed projects.
Those last two paragraphs also smack of trade wars. Currently, China is on the Congressional back burner, but that will change as soon as the US economy stalls even a bit.

China Faces Intense Monetary Tightening

Bloomberg reports Reserves Set for $2.8 Trillion Mean Tightening
People’s Bank of China Governor Zhou Xiaochuan ordered lenders to increase funds on deposit at the authority six times in 2010, as the yuan’s interest-rate advantage over the dollar attracted capital that stoked inflation. The yuan may gain the most among currencies in the so-called BRIC nations, rising 5.4 percent by year-end, compared with a 0.8 percent drop for Brazil’s real, a 0.3 percent increase for Russia’s ruble and 5 percent advance for India’s rupee, according to Bloomberg surveys of strategists.

“We will probably see a round of pretty intense tightening in the first half,” said Ren Xianfang, an economist in Beijing for Lexington, Massachusetts-based research company IHS Global Insight. “The yuan’s appreciation in 2011, particularly in the first half, should be faster than last year.”

The reserves, which exceeded $1 trillion in 2006 and $2 trillion in 2009, will reach $3 trillion by June 30, according to UBS AG estimates.

Premier Wen Jiabao is seeking to sustain the economy’s growth to create millions of jobs each year, while preventing rising prices for homes and food from fueling social unrest. Benchmark borrowing costs for Chinese banks have risen to a two- year high, fuelling an 11 percent decline in the benchmark Shanghai Composite Index of stocks in the past 12 months.

While a stronger currency and higher rates may help tame inflation, they also risk attracting capital from abroad. In November, consumer prices rose 5.1 percent from a year earlier, the most in 28 months, food costs jumped 11.7 percent and property prices gained 7.7 percent, government data show.

“The risk of a widening interest-rate gap attracting hot money inflows may be part of the reason behind the central bank’s inclination to use the reserve ratio tool more frequently than interest rates,” said Wen Pengyong, an economist at Essence Securities Co., a Shenzhen-based brokerage.
Unprecedented Hell In Belgium As Debt Crisis Escalates

Bloomberg reports Belgium’s King to Tackle Political Deadlock as Debt Woes Mount
Belgium’s king will make a fresh bid to end the 211-day post-election deadlock that has left the country without a full-time government and fanned concern that Europe’s debt crisis will widen.

Belgium’s 10-year borrowing costs jumped to an almost two-year high last week, prompting business leaders to demand an immediate coalition deal between feuding parties in the Dutch- speaking north and French-speaking south.

“Financial markets will be merciless if the country doesn’t extricate itself from this unprecedented hell as soon as possible,” billionaire financier Albert Frere told Le Soir newspaper.

For the first time, investors view western European government bonds as riskier than emerging- market debt, the Markit iTraxx SovX Western Europe Index of credit-default swaps showed last week.

European leaders may discuss expanding the 750 billion-euro ($965 billion) financial backstop for indebted nations at their next summit, Handelsblatt reported yesterday, citing German government officials it didn’t identify. German Chancellor Angela Merkel has said she opposes increasing government-funded aid for euro countries and her chief spokesman, Steffen Seibert, said yesterday that “no decision has been taken about widening the rescue fund.”

The extra borrowing cost over German bonds, a gauge of the risk of investing in Belgium, has risen to 126 basis points from 79 basis points on election day June 13.

The spotlight shifts later this week to southern Europe for sales of some of the $1.1 trillion that euro-region governments need to borrow on bond markets in 2011. Portugal will auction bonds maturing in 2014 and 2020 on Jan. 12. Spain follows on Jan. 13 with the sale of bonds maturing in 2016.

Portugal’s 10-year yields rose 50 basis points to 7.10 percent last week, while Spain’s rose 6 basis points to 5.51 percent.
The market has signaled it's all over for Portugal. Spain is next.

Icelandic Way Out

The Telegraph reports Iceland offers risky temptation for Ireland as recession ends
Iceland has finally emerged from deep recession after allowing its currency to plunge and washing its hands of private bank debt, prompting an intense the debate over whether Ireland might suffer less damage if adopted the same strategy.

Iceland's budget deficit will be 6.3pc this year, and soon in surplus: Ireland's will be 12pc (32pc with bank bail-outs) and not much better next year.

The pain has been distributed very differently. Irish unemployment has reached 14.1pc, and is still rising. Iceland's peaked at 9.7pc and has since fallen to 7.3pc.

Iceland's president, Olafur Grimsson, irritated EU officials last month when he said his country was recovering faster because it had refused to bail out creditors – mostly foreigners.

"The difference is that in Iceland we allowed the banks to fail. These were private banks and we didn't pump money into them in order to keep them going; the state should not shoulder the responsibility," he said.

The Irish press reported that EU officials "hit the roof" when Irish negotiators talked of broader burden-sharing. The European Central Bank is afraid that any such move would cause instant contagion through the debt markets of southern Europe.

Comparisons between the Irish and Icelandic banks must be handled with care. Iceland is tiny. It could walk away from liabilities equal to 900pc of GDP without causing a global systemic crisis.

Ireland is 12 times bigger. The balance sheets of Irish banks are $1.3 trillion (£822bn). The interlocking ties with German, Dutch, Belgian, and British banks create a nexus of vulnerability. Bondholder defaults would risk contagion to Spain and Portugal, where the banks rely heavily on foreign capital markets.

Of course, banks are only half the story. Nobel economist Paul Krugman said Iceland has been able to eke out recovery sooner because it never joined the euro.

"Iceland devalued its currency massively and imposed capital controls. And a strange thing has happened: although it experienced the worst financial crisis (anywhere) in history, its punishment has been substantially less than that of other nations," he said, referring to Baltic states pegged to the euro.

Two years later, the krona is down 30pc, aluminum smelters are firing on all chimneys to meet export demand and local produce has displaced imports, including such exotica as vegetables and tomatoes grown in greenhouses.

The underlying tale of Ireland and Iceland, and the tale of the 1930s, is that a devaluation shock may cause a violent crisis – that looks and feels terrible while it happens – but the slow-burn of policy austerity and debt deflation does more damage in the end.
To Ireland With Love

Once again I implore Ireland to tell the IMF and EU to go to hell in response to the IMF's Trojan Horse offering. Flashback November 28, 2010: To Ireland With Love.

I believe we have all heard the story and know how it ends.

Iceland is No Ireland

Inquiring Irish minds just might be interested to see how Iceland fared after they told EU bankers to go to hell. For the answer, please consider Iceland Is No Ireland as State Kept Free of Bank Debt

Iceland’s President Olafur R. Grimsson said his country is better off than Ireland thanks to the government’s decision to allow the banks to fail two years ago and because the krona could be devalued.

“The difference is that in Iceland we allowed the banks to fail,” Grimsson said in an interview with Bloomberg Television’s Mark Barton today. “These were private banks and we didn’t pump money into them in order to keep them going; the state did not shoulder the responsibility of the failed private banks.”

Vote the Bums Out and Tell the EU and IMF to Go to Hell

Unfortunately, the idiots running Ireland's government, especially Minister Brian Cowen, don't see it the way Iceland’s president does.

However, Iceland's government did not see it that way either, but the citizens of Iceland took matters into their own hands and voted the bums out, rejecting "Icesave".

Regardless of what deal Cowen signs, I see no reason it need be binding on the next Irish Parliament. Indeed, I recommend to to citizens of Ireland that they firmly tell their representatives that if they vote for Cowen's proposed budget, they will be voted out of office.

Just Who The Hell Do You Think You Are?

Nigel Farage in a speech before European Parliament says “The Euro Game Is Up… Just Who The Hell Do You Think You Are?"

Words alone cannot describe that video. Please play it.
Iceland told its creditors to go to hell and is better off for it. Ireland can and should do the same.

For still more on the European sovereign debt crisis please see my Sunday post France, Germany Pressure Portugal to Take Aid; No Gov't in Belgium for 210 Days; Private Debt Placements in Portugal; Is China the Red Knight Savior?

Also see Friday's post Italy The Invisible Elephant

If Italy blows, the currency union has had it.

Mike "Mish" Shedlock
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