What Should be Done About the European Mess?

Just a few years ago we were being asked this question about the US dollar, to which we said, the euro is the one that you need to worry about, not the dollar.  Now that it is the euro we are all worrying about, what can be done?

The first answer to us seems to be the most obvious - provide more liquidity.  In spite of what you may read, monetary policy grew too tight in Euroland in March and April of this year and it is still too tight today.  Take a look at the chart below, which is a simpler take on the same kind of measurement that we use when examining US policy.

Click on image to view larger chart.

The basic message from this chart is that positive values for the blue chart denote periods of easy money and negative values denote tight money conditions.  When this indicator turns negative, an indication of tightened real world monetary policy, it almost always precedes stock market weakness and/or recessions in Europe.

Today, the euro is overvalued against the dollar (about 20% by our estimates), and monetary policy needs to ease substantially.  Just take a look at the chart below.  The value of the euro needs to be brought down if leaders are serious about wanting to save that currency. 

Click on image to view larger chart.

Policymakers can have those structural discussions about the euro, like fiscal integration, but right now that's a little like worrying about how to rebuild your engine while you are riding on four flat tires.  Buying tires (providing more liquidity) seems like the no-brainer here.  If the ECB wants to save the euro, it is going to have to hold its collective nose and buy the sovereign debt that others don't want, plain and simple.

Click here to read today's complete Market Comment.

Mark Dodson, CFA

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