The Political Will to Encourage a Weaker Euro Will Continue to Build and Build

August 27, 2014

ECB officials face difficult choices.  Deflationary risks are not fading as they had hoped.  The confidence of businesses and households has started to flounder.  Investors are readying for quantitative easing (QE).  But there are good reasons why until now QE hasn’t been implemented by the ECB in sharp contrast to central bank policies in Japan, Britain and the United States.  First, with 18 different fiscal policies, there’s the difficulty of determining whose assets to buy.  Related to that, the ECB must abide by a web of treaties constricting what operations it is allowed to perform.  For a third thing, shifts in capital market rates have comparatively less effect on Euroland’s economy, which is more reliant on funding from bank loans.  A sharp decline in the euro in current circumstances would be the most painless way to instill a little more inflationary pressure in the euro area and would be preferred by those ECB doubters, who’ve resisted QE in the past. 

One never knows for sure but Japanese deflation might have been prevented had the yen declined in the early 1990s.  Instead, the currency doubled in value from 160 per dollar in mid-April 1990 to 79.85 five years later.  The Japanese government lacked the complicity of the U.S. government to allow the yen to remain weak because the Clinton Administration blamed the U.S. trade deficit on the yen being overvalued.  Equally important, the early 1990s were more inflation-prone than current times.  Oil prices spiked in the summer of 1990 after Iraq invaded Kuwait, and the 1970s-80s inflation virus had not been completely eradicated.  During the final quarter of 1990, CPI inflation hit highs of 4.2% in Japan, 6.3% in the United States, 10.9% in Great Britain, 11.3% in Hong Kong, 6.9% in Australia, 6.4% in Switzerland, 6.5% in Italy, 7.0% in Spain, 3.9% in France, 3.3% in Germany, and 4.6% in Norway.  The harmful potential repercussions from currency depreciation — namely higher inflation, rising long-term interest rates, and a more burdensome foreign debt to service — were shunned by officials like the plague.  Not only were no other governments going to help Japan keep the yen weak, they openly criticized Tokyo officials when they perceived such a strategy to be happening.

There will always be inflation hawks predicting soaring prices just around the corner, just as there are people who still think global warming is nothing more than a figment of Al Gore’s imagination.  But the truth is that 2014 bears scant resemblance to 1990.  In light of the debate happening among Federal Reserve officials over how soon to start raising rates, a plunge in the euro would be a true blessing to U.S. monetary policymakers as well as the Bank of Japan’s Board.  It would buy valuable time, because the dollar wouldn’t just appreciate against the common European currency.  Since the U.S. Memorial Day weekend, the dollar has risen 3.3% against the euro but also 2.0% versus the kiwi, 1.9% relative to the yen, 2.2% vis-a-vis the Swissie, and 1.5% against sterling.  U.S. monetary conditions would tighten initially as a result of dollar appreciation rather than higher short-term and long-term interest rates. 

This year’s Jackson Hole Central Bank Symposium ended in a trail of rumors about a secret Fed/ECB deal made there to weaken the euro.  There’s no way to really verify the validity of the speculation.  There’s also no good reason to keep such a plan hidden in the closet if indeed it was hatched.  Concerted central bank/government cooperation in reconfiguring currency values gets the market’s attention.  After the British government engineered sterling’s gentle glide below the $2.00 threshold in March 1976, the pound fell like a rock to $1.56.  The G5’s open espousal of a weaker dollar in September 1985 didn’t start the market’s reversal but cemented a move that cut the U.S. currency in half in under three years. 

The United States needs a stronger dollar.  Europe and Japan need weaker currencies.  It’s a shame if a plan to effect such a change wasn’t conceived in Jackson Hole, but it’s not too late for officials to jump on the bandwagon.  They simply need to say, “hey, how’d you guess our strategy.  Well, a little currency market interference is just what the global economy needs.  Enjoy the ride.”

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

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