No Moral Bias to the Buoyant Euro

July 25, 2013

Currency markets are not altruistic.  The recent buoyancy of the euro above both $1.3000 and JPY 130 is the latest example that the invisible hand of the market popularized by Adam Smith does not hand out gratuitous favors to those economies in greatest need.  Forward-looking signs are mounting that the nearly two years of recession that the euro area has experienced could be winding down, yet Europe’s outlook remains worse than those of the United States and Japan. 

A weaker euro would not be unwelcome in Euroland from an inflation standpoint.  The latest on-year readings of total and core inflation, 1.6% and 1.2%, are below target and below the pace over the prior twelve months.  Continuing very subdued money and credit growth moreover point to continuing price stability in the medium term.  M3 grew just 2.8% between the second quarters of 2012 and 2013, and credit to the private sector contracted by 1.1% in the year to June according to new data released earlier today.  The weakest euro level of 2012, $1.2041, was touched a year ago yesterday (July 24, 2012), and since that trough, the common currency has appreciated roughly 10% against its U.S. counterpart.  Over a third of that gain has occurred within the past fortnight.  Meanwhile, the euro is also trading some 40% above its year-ago level versus the yen.

Currency markets serve the current account genie more reliably than the relative economic growth genie.  The U.S. current account deficit still equals around 3% of GDP.  Chronic trade deficits in Japan have depleted that country’s current account surpluses.  But in the euro area, a tiny current account deficit equal to 0.1% of GDP in the first quarter of 2012 was transformed into a surplus of at least 1.5% of GDP by last quarter.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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