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,
Editorial Director, Taipan Publishing Group
****
Justice Litle is the Editorial Director for Taipan Publishing Group and the
e-letter, Taipan Daily, the free financial e-letter that introduces readers
to breaking global trends and investment strategies.
DISCLAIMER: All of the provided information is believed to be accurate, however errors are possible. The opinions in the Commentary section do not necessarily reflect the opinions of GoldIRAS.com. Past performance of any investment is no guarantee of future performance. All investments have risk.
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