Jackson Hole Preview: Draghi's Plan Should Net Positive for Markets
By Vince Foster Aug 20, 2012 10:00 am
Draghi has done the math, knows the formula, and understands the channels through which a devaluation needs to work. He knows it's not just about trade, it's about real wealth and income and effects on capital investment.
Conclusion (emphasis mine):
It has been shown that a devaluation affects the domestic price level and the relative price of non-traded goods in terms of the traded ones in the same way as it does in the monetarist model. However given the different specifications of the demand functions for goods and for assets, the channels through which a devaluation works are different from the monetartist model. In particular it has emphasized the fact that since demand for money is a positive function of real income and real wealth, changes in relative prices or in the absolute price level-such as those caused by a devaluation-that decrease real income and real wealth may decrease the flow demand for money and therefore may not improve the balance of payments of the devaluing country.
Hmmm... Draghi's point seems to be that yes all else equal a devaluation will adjust the trade imbalance through the rising price level positively affecting the current account but that the resulting decrease in real wealth due to higher prices will drive a decrease in capital flows which will negatively affect the capital account thus not improving the overall balance of payments.
I don't know if Mario Draghi has the right answers but he certainly has been thinking about how to effectively tackle a balance of payments crisis for a long time. It's quite possible he's the most qualified man on the planet to address the crisis in Europe and I'm not sure US investors have the respect that he deserves.
In reading his dissertation it's clear that he's a contrarian analytical thinker with a deep understanding of all the moving parts and how they relate to one another. The very fact that he was so focused on the market side of the balance of payments equation suggests that he understands how important it is to address the market's concerns and not just the political concerns.
Jackson Hole Symposium
The Jackson Hole symposium is shaping up to be one of the most interesting in recent memory. Scheduled over the Labor Day weekend traders will have the much anticipated Bernanke speech on Friday 8/31 but will also have to contend with Saturday's speech by Draghi as they position for month end and the post Labor Day trade. With recent economic data improving at the margin and some more hawkish rhetoric out of Fed speak it's quite possible that Bernanke's speech is more muted than many expect. Maybe the focus should be on Draghi who may use the symposium as an opportunity to expound on his pledge to do what is necessary to safe the euro from collapse.
On the surface it would seem both the Fed and the ECB want their respective currencies lower.
But maybe Bernanke would actually benefit from a weaker euro if it is the best path to fixing the eurozone crisis which would improve global risk appetite. That has started to show up in the performance of Treasuries, European stocks, and European financial credit spreads. Jackson Hole could see a continuation of that trend if Bernanke backs off QE and Draghi steps up to offer concrete solutions to fixing the European imbalances.
Every time I see Super Mario I can't help but think about the striking resemblance to one of my childhood heroes Count von Count on Sesame Street. Ah! Ah! Ah! One of my favorite episodes was when the Count plays Beat the Time hosted by Guy Smiley. They call me the Count because I love to count things. Then right on cue, the Count wins the "Impossible Stunt" by simply counting.
It seems Draghi is up against the clock himself and is playing his own version of Beat the Time. It also seems Draghi has done the math, knows the formula, and understands the channels through which a devaluation needs to work. He knows it's not just about trade, it's about real wealth and income and effects on capital investment. All else equal that should be net positive for markets and the future for eurozone.
No positions in stocks mentioned.