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Welcome To The Almost Free Lunch


Free lunch?! I am there baby

In my deepening sense of puzzlement over the behavior of interest rates vis-à-vis the falling dollar, I asked the "Iron Horse" when will the foreign central banks start caring about their currency losses and demand higher rates. His answer was: never, because central banks do not operate with an eye toward their P/L. I will confess that I have never considered that possibility. I always assumed that they either care but politically can't do much about it, or care but have ulterior motives to keep buying a low yielding - fast depreciating asset. That a central bank flat out does not care about losing money seems to merge the concepts of "it's other people's money" and "if we lose some, we'll just print more" into the toxic concoction known as the "Free Lunch".

However, I will offer some chatter that has been making the rounds of the European press and was recently highlighted by the Stratfor service, which may at least put a wrinkle in the Central Banks' "we do not care approach." Germany apparently includes in its deficit computation the P/L of the Bundesbank, and this year the Bundesbank was foreseen having a net profit: but that was before the Q4 tanking of the dollar vs. the euro. With the Bundes' profits evaporated, the wider deficit is now putting Germany once again outside the Maastricht's deficit bands.

Does this matter and does Germany care? In the aggregate probably no. Germany and France have always made it a point that the Maastricht rules were invented by them but only really apply to the "lesser countries" of the EU, which include all countries except France and Germany; and there was never really a worry that they would be slapped with the scheduled sanctions because they effectively controlled the commission charged with enforcing the bands.

But the scenario has somewhat changed now. The new commission is not nearly as friendly as it used to be and could make life more difficult for both France and Germany and perhaps exact other types of economic concessions in exchange for busting the bands. And in a twist of Enronian accounting, France is now suggesting that defense, research and development spending should be excluded from the deficit computation because it constitutes "productive" spending.

I have certainly not thought through other arguments that might dispel the existence of a "Free Lunch". I am sure they are out there and I'd love to hear them. And circling back to the Iron Horse, from a practical standpoint there is little doubt from the behavior of the markets that such arguments do not seem to matter. But whatever Germany will give up to be allowed to continue its free wheeling deficit spending, and whatever government spending France will feel compelled to sweep under the rug, are both marginal signs that there may be at least a vague price to pay for "not caring" about losing money
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