The Eurozone Debt Crisis and the US Dollar

It was reported today in the financial news that China bought more U.S. Treasury debt in September, after cutting its purchases of US Treasuries in August by 3.1%.

Total foreign holdings of US Treasury debt rose for a second straight month, according to the Treasury, with total foreign holdings increasing 1.9% to $4.66 Trillion. China, the largest foreign holder, bought 1% more to bring its total holdings to $1.15 Trillion.

This suggests that foreign demand for U.S. debt remains strong, despite a prolonged congressional debate this summer over increasing the nation's borrowing limit. Investors don't appear to be concerned that Standard & Poor's downgraded the credit rating on long-term U.S. debt. S&P said it lowered the U.S. credit rating because of politics that slowed the debt limit increase and not because it thought the U.S. couldn't pay its bills.
There was other important financial news today. German Chancellor Angela Merkel said that Germany is ready to give up some sovereignty in order to strengthen the Eurozone and restore confidence in the common currency.

Merkel’s remarks were made at the joint briefing following her meeting with Irish Prime Minister Enda Kenny. European Union treaty changes to strengthen European Union institutions and supervise tighter budget rules are needed “to make the Eurozone more crisis-proof,” Merkel told reporters in Berlin.

“Germany sees the need...to show the markets and the world public that the Euro will remain together, that the Euro must be defended, but also that we are prepared to give up a little bit of national sovereignty,” Merkel said, adding that Germany wants a strong EU and a Euro “of 17 member states that is just as strong and inspires confidence on international markets.”

Germany, the largest contributor to Euro-area bailouts, is ruffling feathers with its plans for an overhaul of the EU’s guiding rules (treaties). U.K. Prime Minister David Cameron has already rebuffed Merkel’s proposal for treaty change, saying that the crisis offers the opportunity to allow power to “ebb back” to national states from Brussels.

Merkel explained that treaty change would mean “an intervention and oversight role in respect of the preparation of national budgets, but with flexibility to certain countries to do their own particular budgetary strategy.”

“We have an absolute interest in the continued strength of the European Union and the stability of the Eurozone and the Euro,” Irish Prime Minister Kenny said, but even so, “any steps toward major treaty changes would be very challenging….We had a frank conversation about that.”

Merkel said that the existing treaties mean that the European Central Bank “doesn’t have the possibility of solving the Euro problem.”

Markets in Europe apparently were not happy with these remarks, which were followed by the French Finance Minister saying that amending the EU treaties is not necessary, but that Germany should agree to allowing the European Financial Stability Facility (EFSF) to hold a banking license so that it could buy and sell the bonds of countries in the Eurozone.

This is the European and the Euro problem in a nutshell. France and Germany have still not agreed on how to solve the Eurozone sovereign debt crisis. Most EU countries are not interested in re-opening the EU treaties because they would have to be ratified by either sceptic parliaments or by votes of citizens who are beginning to realize that whatever happens, they are going to be left holding the empty Euro sovereign debt bag and will have to re-fill it through higher taxes and severe cutbacks in government services.

All this indecision and bickering caused the European bond markets to become very nervous. Spanish and French 10-year bonds sold at higher than expected interest rates, meaning that these two Eurozone countries are probably now beginning to feel the effects of the European indecisiveness in their bond markets. This could truly be the death knell for the Euro, since Germany would then stand alone against the sovereign default of the entire Eurozone. European financial analysts are today talking about Italy already being lost and the next battlefield quickly becoming Spain.

But, there was a positive effect for those holding US Dollars. The Dollar rose today against all major currencies except the Japanese Yen, and the Euro hit a five-week low against the Greenback.

After a relative had died in London and the story was picked up in America as Mark Twain's having died, Twain wrote a handwritten note in May 1897 saying, “The report of my death was an exaggeration.”

Perhaps this often-used quote also applies to the Dollar. All those wringing their hands about it losing its reserve currency status might want to take notice of today’s events. This is not to say that America can relax and do nothing about its own sovereign debt burden, but today’s financial markets gave the Dollar a vote of confidence which ought to encourage America to get on with what it knows it has to do - reduce its long-term debt and annual budget.