1. GLOBAL MACRO RESEARCH
FX CONCEPTS
CURRENCIES INTEREST RATES EQUITIES COMMODITIES
MARKET INSIGHT REPORT
A 1992 Rerun As the UK Steps Out of Trouble
December 15, 2011
By John R. Taylor, Jr.
Chief Investment Officer
The Euro-leaders told everyone that the summit in Brussels last week would be a watershed event. It
wasn’t, but in the washout that followed the only significant result seemed to be David Cameron’s
decision to take the United Kingdom out of these tragic negotiations. One wag noted that Cameron’s
departure had saved the European Union and its 27 members from the indignity of an impossible task,
reworking the supporting treaties of the European Union. Now, the remaining 26, soon to be many
fewer, will be starting with a blank sheet, hoping to write a new defining document for the Eurozone,
plus other adherents. Anyone who has agreed to sign this new document has done just that – signed a
blank sheet – one that would be written 26 different ways if each country were to have its wishes.
Although this could be the Eurozone’s first step toward creating a fiscal union, a grouping that we would
argue must be a United States of Europe (USE) – sorry for the name and my apologies to Euro-
denizens, but a USE is the only possible successful end-state – this road will be very arduous and
impossibly long, probably spanning several lifetimes. The UK doesn’t want to risk its society and its
golden egg, the City of London. It has opted out again! Even the most stubborn Europhile should get
the drift: the UK is not part of Europe. The UK has stepped out of Europe just like the newborn Upper
Canada stepped out of the fledgling US during its war of liberation. The Canadians avoided the wars
back then, just as the British will skip the agony of the “internal devaluations” today, which might
eventually prove a living hell for those forced to endure it. Eventually Canada developed into a different
society, one that some would say was less successful than the US and others would say was far more
so. England’s antagonism with Europe is a long one. Queen Elizabeth and Drake repulsed Europe in
1588 when the Spanish held sway, once again in the early nineteenth century when Napoleon ruled
Europe but could not suppress the island beyond La Manche (even with the Continental System), and
most recently in the 1940’s when Hitler was the most horrifying of all the euro-menaces. To many, this
recent invasion seems a peaceful one, but the UK has always had a high proportion of euro-skeptics in
powerful places. Cameron’s bold stroke has given them the victory.
In September of 1992, when the pound was forcibly ejected from the ERM, the predecessor to the euro,
it seemed a humiliating defeat for John Major, the British PM, however, the aftermath was nothing but a
glorious success for the British economy. Major never lived down the economic slap in the face that he
suffered, but London boomed and, from one end of the island to the other and even over to Northern
Ireland, the good times began. They did not end until 2008 by our anecdotal reckoning. So powerful is
the fuel of liquidity that the UK enjoyed the best stretch of any of the developed countries. Compare
this with the result over on the continent where the ERM eventually became the euro. Now, the
question is, will this happen again? We don’t see why not, except for one fact. This time the UK will
be the boat that floats and the Eurozone will be the one that swamps and threatens to sink. Over the
next three to five years, it is not that good times are coming to the British but that worse times will be
avoided. In the financial area, the British Treasury, the Bank of England, and the FSA should have an
easier time managing the liquidity and solvency risks that will be so prevalent in the banking world than
the European authorities will. If they do a good job of this, the position of London as the financial hub of
Europe will be improved. There will be plenty of European corporates that will need financial and work-
out help and even the Eurozone Treasuries will have to turn to London for financial help.
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2. GLOBAL MACRO RESEARCH
FX CONCEPTS
CURRENCIES INTEREST RATES EQUITIES COMMODITIES
CURRENCY – Europe Long-Term View
Are the Germans Intentionally Trying to Kill the Euro?
By Jonathan Clark
Germany is the dominant country in the
Eurozone and exercises outsized
influence on both central bank and fiscal
policy. German paranoia about inflation
resulted in the ECB being slow to ease
interest rates during the 2007-2009
global recession as well as what we
believed was an ill-advised interest rate
hike in April of this year. The transition
of leadership at the central bank from
Trichet to Draghi is seen as a move
away from conservatism, but we are yet
to be convinced it has emerged from the
shadow of the Bundesbank. Last week,
the ECB introduced a number of
changes, but what was lacking was a
commitment to either large-scale
purchases of Eurozone sovereign debt
or any measures that would boost the economy. These may eventually come, but
currently the Central Bank is running a far too tight policy considering the widespread
belief that the Eurozone is already in a recession that will last between one and three
years. Germans believe fiscal policy should require Eurozone members to hold to rigid
targets, but there will be growing resistance from a number of countries concerned about
slowing economies. The IMF is forecasting the Greek economy will shrink 6% in 2012.
On Tuesday, Chancellor Merkel told a meeting of her Christian Democratic caucus that
the cap in the bailout fund of €500bn will stay in place, eliminating one possible way of
rescuing countries as fiscal problems escalate, but in the meantime the faltering
Eurozone economy will drag down the euro. The ECB will have no choice but to turn on
the monetary spigots through large purchases of sovereign debt and when this occurs
the euro will collapse just as the US dollar did when it embarked on quantitative easing.
Either intentionally or unintentionally the Germans are weakening the euro.
The euro has fallen 3% this week and is approaching oversold levels on a short-term
basis. It should bottom on Thursday, holding above 1.2880 and then turn higher to
make at least a weak recovery into the final trading days of the year. We are not
expecting it to surpass the resistance around the 1.3200 area and, if seen, this
should be a good place to sell. It should then resume its downtrend into the second
half of January and our minimum target for this low is the 1.2500 area. The longer-term
cycles call for this overall weakness to last into May at a minimum and as long as the
fourth quarter of the year. Our longer-term objective is the 1.1200 area.
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