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Among
its many other sins, the greenback is a press hog. The world’s reserve
currency, loved and loathed as it is, simply gets most of the ink these days.
In
that light many a U.S.-based commentator, not least your cynical Taipan
Daily scribes, have repeatedly waxed eloquent on the long-run death of
the dollar.
But
in our zeal we sometimes forget that, in order for the dollar to die, it has
to die relative to other fiat currency offerings... and some of those
others are looking pretty sick too. (The main exception, of course, being
gold - the one and only “stateless currency” not subject to the
whims of a printing press. As Grant’s Interest Rate Observer
quips, “Show us a monetary asset whose value is not subject to
governmental debasement and we will show you a Krugerrand.”)
In
short, the dollar is not the only basket case out there. Take the euro, for
example. Now there’s a troubled currency if ever one existed.
As
pollyanna stock market bulls are finding out the hard way, rising interest
rates (via falling bond prices) can have ugly consequences. The same is true
of a rising currency when coupled with a weak economic backdrop.
In
this particular case, the stronger the euro gets, the more it cuts into
European export sales. At a time when most all of Europe is sick, the economic
pain of a too-strong currency becomes intense above a certain threshold.
On
top of that, various bits of Europe are in the process of blowing up... or
falling apart... or both. There is deep trouble brewing in multiple corners
of the continent. Let’s take a quick look on a country-by-country basis
to see why Europe is being held together with duct tape.
Britain
on the Brink
We’ll
start with Britain - not an adopter of the euro, but a member of the EU
(European Union) nonetheless.
Britain
has been hurled into political chaos, thanks to an unholy combo of deep
financial crisis, explosive Labour Party scandals, and the hapless lame-duck
status of embattled Prime Minister Gordon Brown. Cabinet Ministers are
resigning left and right in protest as Brown’s popularity plummets,
calling for the PM to step down. Election results tallied this week showed
the Labour Party (Brown’s party) putting in its worst showing since
1918.
Philip
Stevens, chief political commentator for the Financial Times, sees an
ominous chain of events now set in motion. “Everyone thought the
[election] results would be bad,” Stephens reports. “But these
[results] are calamitous... the Prime Minister was prepared, if you like, for
very bad results. He’s now got to grapple with absolutely terrible
results.”
If
the Brown government fails, Britain will be left rudderless in the midst of
the worst fiscal storm in decades. In a worst-case scenario where bad events
lead to worse decisions, opines Stephens, the domino chain could even lead to
a British exit from the EU.
This
outbreak of chaos is awful and unsettling for the British economy - and by
extension awful and unsettling for Europe. As of this writing, it is not yet
clear whether Prime Minister Brown can survive a political coup... or even whether
he would be better off resigning, Dick Nixon style, in the interest of
sparing greater turmoil.
Latvian
Pressure Cooker
Elsewhere
in Europe, Latvia, a tiny country of 2.2 million, threatens to unleash havoc
on the entire continent.
Latvia’s
currency, appropriately known as the lat, is officially pegged to the euro.
Latvia set up the currency peg to speed up official entry into the EU. But
now the fiscal discipline of maintaining the peg is crushing the Latvian
economy.
At
one time, Latvia was an Eastern European tiger, growing by leaps and bounds.
But, like many other countries, Latvia found itself badly caught out by the
financial crisis. Just when credit lines were needed the most to shore up a
cratering home front, Latvia found it suddenly impossible to borrow. Credit
was desperately needed. An attempt to issue $100 million worth of
lat-denominated bonds resulted in no takers.
Normally,
a small country with an imploding economy would simply devalue the currency
to make exports more competitive. But if Latvia devalues now, all kinds of
ugly fallout will follow.
For
one, the Swedish and Austrian banks that lent heavily to Latvia would take
huge, destabilizing losses. Worse, other Eastern European neighbors, like
Lithuania and Estonia (and Bulgaria farther south), would see their own
currency pegs threatened.
And
even worse still, a wholesale lat devaluation would crush many Latvian
businesses (due to loads of foreign currency-denominated debt on the books)
and kill Latvia’s shot at eventual EU acceptance.
So,
with the help of emergency financing from the IMF and European Union, Latvia
has vowed to keep on keeping on. The currency peg will not go undefended. But
in order to maintain that peg in the face of economic hardship, Latvia will
need to cut wages and spending to the bone. This, too, is dire medicine for a
small country struggling under the weight of great debt.
Some
believe Latvia will be forced to devalue, in spite of all the pain it would
cause for both the tiny country itself and many surrounding neighbors. The
pressure might just prove too great, as the pressure was too great in 1992
when Britain was forced to devalue the pound and drop out of the European
Exchange Rate Mechanism (ERM).
In a
way, Latvia is damned if it does and damned if it doesn’t. Some argue
that the peg must be defended at all costs, lest the whole of Eastern Europe
be lost. If Lithuania and Estonia are sucked into a currency pain vortex, the
EU could lose its political hold on the region - and Russia could rush in to
fill the torment-filled vacuum.
It
would be so much easier (and simpler) if the value of the euro were to fall
from current high levels. This would ease Latvia’s pain, as well as a
number of other struggling countries. But there is a huge and intractable
obstacle there - Germany.
Germany
in a World of Its Own
As
the global financial crisis has unfolded, Angela Merkel, the Chancellor of
Germany, has been looked on with increasing amounts of admiration and horror,
depending on the observer’s vantage point.
Those
who admire Merkel do so because Germany has appeared to completely go its own
way in the midst of turmoil. As other countries have stimulated and relaxed
and eased to fight the fires of slowdown, Germany has said
“Nein!” to anything that smacks of lax fiscal policy.
In a
speech last week, Chancellor Merkel even went out of her way to slam the
Federal Reserve and the Bank of England, stating plainly that “I view
with great skepticism the powers of the Fed... and also how, within Europe,
the Bank of England has carved out its own line.” Within the subtle
context of diplomacy and statecraft, those are amazingly blunt words. Merkel
has all but called the stimulators a bunch of out-of-control fools.
Many
admire Germany’s fiscal backbone. But others are horrified, and
terrified, by Germany’s lack of willingness to show any type of bend or
flex in monetary policy.
Remember
the Latvia problem? Many other rapidly imploding European economies, like
those of Ireland and Spain, are also struggling with the weight of a
too-strong euro hurting export prospects. But in its zeal for fiscal
responsibility, Germany will probably remain steadfast in its opposition to
any loosening of the purse strings.
The
stance is cultural and historical. Having lived through the horror of hyperinflation
in the Weimar Republic in the 1920s, Germany emerged from its baptism by fire
as a zealous hard-money advocate. Rigid fiscal discipline has been a
political rallying cry in Germany ever since. So when Chancellor Merkel takes
an especially hard line against the easy-money inflationists, she is doing so
with an eye for public approval ratings at home.
The
trouble is, even Germany can barely afford its own righteousness. The German
economy still depends heavily on exports... and so an overly strong euro
hurts Deutschland too.
The
Rise of the Far Right
Last
but not least, a surprising new trend has arisen from the EU-wide elections
held in the past few days.
“Conservatives
raced toward victory in some of Europe's largest economies Sunday,” the
Associated Press reports, “as initial results and exit polls showed
voters punishing left-leaning parties in European parliament elections in
France, Germany and elsewhere.”
The
rise includes not just the right, but the far right. In Britain, the British
National Party - an openly racist party that only admits whites - gained a
seat for the first time. In various other countries, openly nationalist
parties gained fresh power either for the first time also, or for the first
time in quite a long while.
“It
is not clear why a chunk of the blue-collar working base has swung almost
overnight from Left to Right,” says Ambrose Pritchard of the U.K.
Telegraph. “But clearly we are seeing the delayed detonation of two
political time-bombs: rising unemployment and the growth of immigrant
enclaves that resist assimilation.”
A
Poisonous Stew
There
are still other problems in Europe we haven’t really touched on, like
the Spanish real estate markets headed for freefall, the dire state of the
Irish economy (joke du jour on the Emerald Isle: What’s the difference
between Ireland and Iceland? The letter ‘C’) and the toxic
leverage still lurking in European banks.
Put
all this together, and what you get is a truly poisonous stew. Half of Europe
is still committed to fiscal stimulus and economic coordination... while the
other half has swung inward and hard right, towards a nationalist and
isolationist stance, at a time when exports are weak and the whole continent
is in trouble.
If
Pritchard is right in his gloomy assessments, we could be witnessing a
scenario where steely fiscal discipline, though a virtue early on, becomes a
terrible vice this late in the game. “The irony is that those fretting
loudest about inflation may themselves tip us into outright deflation, with
all the perils of a debt compound trap,” Pritchard opines. “It is
Angela Merkel who plays with fire.”
By
now the trading takeaway should be fairly obvious. The dollar is not the only
paper currency with crash and burn potential. The euro could make for one
hell of a great short when the time is right. Whether that time comes sooner
or later depends on how events unfold... and how quickly the threat of
deflationary vice grip leads to inflationary panic (as ultimately occurs in
all unsound paper regimes, when the desperate hope of the printing press is
embraced as last resort). Macro Trader will be watching the charts
with keen interest.
Justice
Litle
Taipan Publishing Group
Justice
Litle is the Editorial Director of Taipan Publishing Group
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