Governments Challenged

July 24, 2014

It a conventional to think that currencies are apt to weaken when governments fail to meet important challenges properly.  Governments these days are struggling to deliver prosperity, peace and world respect. 

Soft productivity growth is one of America’s central problems.  It prevents faster growth in jobs from boosting GDP growth, and it could force the Federal Reserve to lift interest rates sooner than officials would like.  The stagnation of incomes for much of the population is another failure of government, and a lack of trust in the Obama Administration by U.S. allies and foes is a third stain on the nation.  Legislative gridlock caused by the polarization of politics was once considered a good thing by the marketplace but no longer because of feared damage caused by a lack of long-range planning.

In spite of these festering misgivings about the state of America, July has been a good month for the dollar thus far.  There have been gains of 1.8% against the Swiss franc, 1.7% relative to the euro, 2.3% relative to the kiwi, 0.6% versus the loonie, 0.2% against sterling and 0.1% versus the yen.  Other economies are grappling with issues with more pressing relevance to currencies.

The credibility of the European Central Bank is being tested by a long stretch of inflation substantially below the central bank target.  On-year CPI inflation of 0.5% in three of the last four months is as far away from target as 3.1%.  It’s almost August, and euro area inflation first dipped under 1.0% in October of last year.  Inflation has averaged 0.9% for the past year and a half.  Investors wonder why it has taken so long for Europe’s best and purportedly most enlightened institutional officials to recognize the danger of deflation.  Inflation of 0.5% or less needn’t be harmful to the euro.  The yen appreciated quite far over a span characterized by moderate deflation.  In Europe, however, the image of predictably stable inflation just south of 2.0% has been carefully cultivated as the gateway to other desired objectives.  What’s the point of more integrated government in Europe that cannot deliver single-digit unemployment, sustainably positive economic growth, and a more coherent and responsive foreign policy to elevate the region’s influence in that area?  The euro’s Achilles Heel is the same name as it was at conception.  By surviving without any defections for 15-1/2 years, it has perhaps beaten the early odds, and it may remain intact for another five, ten, or twenty years.  Still, doubts persist that it will be as permanent as the dollar or yen.

Economic growth averaging 0.9% per year over the past twenty years, public debt equal to around 250% of GDP, and the disappearance of a once-chronic trade surplus are but three of Japan’s serious problems.  The population is shrinking and ageing, and the economy is damned both if it reconsiders domestic nuclear energy policy or it remains reliant on imported fossil fuels.  A long history of resorting to currency depreciation when all else fails hasn’t worked this time.  Export volumes were unchanged between the first half of 2013 and 1H14. 

A large theme of all financial markets in 2014 has been the proliferation of separate but seemingly related geopolitical risks and the lack of influence that such threats have exerted on investor behavior.  A favorite explanation is that all factors are trumped by the continuing ultra-accommodative monetary policies.  I doubt that’s all of it.  So much has changed already this century in how information is distributed and how financial instruments are traded that it would be odd if long-experienced behavioral patterns didn’t mutate in unanticipated ways.  If market inertia simply reflects monetary policies, the lack of action shouldn’t persist too month months longer.  The Fed may not hike rate before next spring, but hints to that effect will pick up in frequency by autumn.  Officials at the Bank of England are already chomping at the bit to raise their key interest rate before yearend.  It’s been pinned at 0.5% since March 2009.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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