One British view of the choice confronting Germany...

Martin Wolf of the The Financial Times concludes that Germany's choices are these...

"Germany must choose between a eurozone disturbingly different from the larger Germany it expected, or no eurozone at all. I recognise how much its leaders and people must hate this choice. But it is the one they face. Chancellor Angela Merkel must dare to make that choice, clearly and openly."


For his analysis, see 
http://www.ft.com/intl/cms/s/0/c3085eb4-202d-11e1-9878-00144feabdc0.html#axzz1gXTdpMke

Paul Volker's analysis of how we got where we are...

Excerpts from his Taylor lecture:

"Now, we know all the seeming mathematic precision brought to task, epitomized by calculations of Value at Risk, complicated new structured products, the explosion of derivatives, all intended to diffuse and minimize risk, did not bear out the hopes. Instead the vaunted efficiency

helped justify exceedingly narrow credit spreads and exceedingly large compensation. By now it is pretty clear that it was faith in the techniques of modern finance, stoked in part by the apparent huge financial rewards, that enabled the extremes of leverage, the economic imbalances, and the pretenses of the credit rating agencies to persist so long. A relaxed approach of regulators and important legislative liberalization reflected the new financial Zeitgeist.

If those remarks sound critical – and they are meant to inspire caution - let me emphasize that the breakdown in financial markets and the “Great Recession” are the culmination of years of growing, and ultimately unsustainable, imbalances between and within national economies. These are matters of national policy failures and the absence of a disciplined international monetary system."

"..the build-up in leverage, the failure of credit discipline, and the opaqueness of securitization -- all the complexity implicit in the growth of so-called “shadow banking” -- helped facilitate accommodation to the underlying imbalances and to the eventual bubbles to a truly dangerous extent. In the end, the consequence was to intensify the financial crisis and to severely wound the real world economy."

Fasten your seat belts...

The European crisis is snowballing. If the question were just whether European governments can act in time to prevent a full-fledged run on Italy and Spain, it would be be bad enough. That the Europeans don't agree on what needs to be done to prevent a re-run of the post-Lehman crisis makes these days much more frightening. An already ugly situation is getting uglier by the day.

Mexico is feeling the fallout. At the beginning of August, the fix rate was a peso lower than it was today, Monday, September 12. The IPC (Mexican stock index) has dropped 2,000 points. Expectations about interest rates have changed dramatically: if the Banco de Mexico moves the Mexican reference rate before the end of next year, odds are that it will lower it, not raise it. It's not just the financial markets that have been hit. With US growth projections being cut, Mexico's projected growth rate has been reduced. Growth should still receive a boost next year from the presidential election but it won't be enough to counteract the dampening effect coming from the US.

Yet another trade surplus for Mexico...

For the sixth consecutive month, Mexico ran a surplus in its trade account. At US$107.9 million, June's surplus was the smallest of this year, but the fact that the trade account was in surplus while the economy is growing is striking. The 44.3% increase in oil revenues through June (compared to the first six months of 2010) was complemented by the 19.9% growth of non-oil exports.

In the first half of this year, the trade surplus totaled US$3.34 billion, 1,058.1% higher than in the first half of 2010. In the first half of 2009, the trade account was in deficit to the tune of US$1.84 billion. However, if oil is excluded from the calculation, the trade account showed a US$3.69 billion deficit through June; that was 21.0% less than in the first six months of 2010.

Investment

The gross fixed investment (GFI) figures for December were published today, ten weeks after the year ended. GFI rose a less than impressive 2.3% last year. While GDP (in current pesos) might have recovered its 2008 by the final quarter of 2100, GFI certainly wasn't driving the recovery: GFI dropped 10.1% in 2009.

GFI in machinery and equipment rose 4.3% last year, After plunging 18.7% in 2009, GFI in nationally-produced machinery and equipment climbed 13.3%, its fastest growth rate in seven years. Imported machinery and equipment inched up a mere 0.8% in 2010 after plummeting 22.0% in 2009. It will be interesting to see if this is a one-time effect or presages a switch in sourcing. Construction

Will the Fed put an end to monetary stimulus this year?

The Mexican government doesn't think so, if the wording in the statement issued on June 23 by the Council on Financial Stability (CESF, comprised of Hacienda, Banco de Mexico, the CNBV, the Insurance Commission, the Consar and the IPAB -- in short, the financial regulators) is any guide. The CESF does not expect the Fed to "retire the monetary stimulus before the beginning of 2012".

The consequences are interesting: "therefore, the risk that capital flows to emerging markets will revert when US monetary policy is normalized has diminished. Nonetheless, risk persists due to the financing needs or renewed volatility caused by the fiscal problems of developed countries." In other words, we're not out of the woods yet.

Risks to Mexico's banking sector

When the official body charged with assessing the stability of Mexico's financial system (Consejo de Estabilidad del Sistema Financiero) issued its first report yesterday, it gave Mexico's financial system a clean bill of health. The Council (CESF) is presided over by Hacienda and its members include Banco de Mexico, the CNBV (National Banking and Securities Commission), the CNSF (National Insurance and Bond Commission), the Consar (National Commission for Retirement Savings), and the IPAB (Institute for the Protection of Savings in Banks).

The CESF, the latest in the string of anacronyms overseeing the financial system, did observe that "an abrupt reversion of capital flows toward Mexico" could have have "unfavorable impact" but that it would be limited, thanks to actions taken by the government in recent years. The CESF also stated that "the Mexican economy has been capable of absorbing in an orderly manner the elevated capital inflows it has received recently and without generating distortions in the principal financial variables". The CESF goes on to assure us that "(T)he underlying conditions of the Mexican economy are solid and growth perspectives, favorable."

Finally, the CESF concludes that although "the indebtedness of states and municipalities does not presently represent an important problem for Mexico's financial system, it is necessary to generate adequate incentives to improve transparency and promote prudent fiscal policies by states and municipalities." Amen.

Investment

The gross fixed investment (GFI) figures for December were published today, ten weeks after the year ended. GFI rose a less than impressive 2.3% last year. While GDP (in current pesos) might have recovered its 2008 by the final quarter of 2100, GFI certainly wasn't driving the recovery: GFI dropped 10.1% in 2009.

GFI in machinery and equipment began to recover from its 21.0% plunge in 2009, rising 4.3% last year. Construction, the other main component of GFI, gained 1.2% in 2010, after falling 2.3% in 2009.

GFI in nationally-produced machinery and equipment climbed 13.3% in 2010, its fastest growth rate in seven years; in 2009, it dropped 18.7%. Imported machinery and equipment inched up a mere 0.8% in 2010 after plummeting 22.0% in 2009. It will be interesting to see if this is a one-time effect or presages a switch in sourcing.

Interview with Ambassador Davidow

On Tuesday I gave a "Tequila Talk" at the Institute of the Americas. (Yes, they did serve tequila.) To see the interview, just click on the following link:

http://www.iamericas.org/en/ioa-videos/Tequila-Talk-with-Deborah-Riner/0/35/1