Euro Falling, US Recovery Under Threat

Intensified fears over government debt in the eurozone are pushing the euro weaker against the dollar.  The G7 achieved nothing over the weekend, the IMF is stuck on the sidelines, and the Europeans are sitting on their hands at least until a summit on Thursday.  There is a lot of trading time between now and then – and most of it is likely to be spent weakening the euro further.

The UK also faces serious pressure, and there is no telling where this goes next around the world – or how it gets there.

There may be direct effects on the US, as our banking system remains undercapitalized.  Or the effect may be through making it harder to export – one of the few bright spots for the American economy over the past 12 months has been trade.  But this is unlikely to hold up as a driver of growth if the euro depreciation continues.

Some financial market participants cling to the hope that the stronger eurozone countries, particularly Germany, will soon help out the weaker countries in a generous manner.   But this view completely misreads the situation.

The German authorities are happy to have the euro depreciate this far, and probably would not mind if it moves another 10-20 percent.  They are convinced that they must – in fact, should – export their way back to acceptable growth levels.

Competitive depreciation is of course a no-no in international policy circles.  But if your dissolute neighbors – with whom you happen to share a credit union – threaten to implode their debt rollovers, and makets react negatively, how can you be held responsible?

Germany and France have no objection to euro depreciation – they are confident that the European Central Bank can prevent this from turning into inflation.

It’s the US that should be concerned about the effect on its exports (and imports; goods from the eurozone become cheaper as the euro falls in value) if the euro moves too far and too fast.  But the US failed to raise the issue with sufficient force at the G7 finance ministers conclave in Canada and the course is now set – at least until Thursday.

The euro depreciates, the dollar strengthens, and our path to recovery starts to run more uphill.

And if these European troubles start to be reflected in difficulties for leading global banks over the next few days or weeks, the negative impact will be much greater.

By Simon Johnson

44 thoughts on “Euro Falling, US Recovery Under Threat

  1. Well, of course I am looking forward to My Big Fat Greek Default.

    But doesn’t a weaker Euro lighten the debt burden of Greece, Spain, Portugal, etc.? And isn’t that precisely what they need at this juncture?

  2. Contrary to what Geithner had to say on This Week to Jake Tapper, our recovery is incredibly fragile. As you pointed out, even in the face of continued economic weakness, our TBTF’s have been more interested in trading (including foreign currencies, alas) their way to megabonuses than strengthening their balance sheets, which remain riddled with toxic acidity. If the euro gets as weak as you seem to feel that it will, absent unlikely cooperation from the stronger countries, the balance of trade will experience a massive negative shift, and thus further weaken the paroxically slow quasi-recovery, and unemployment will take a far larger hit as our export community braces for massive contraction.

    It’s such a shame, that the (laughable) G-7 is beyond repair in terms of taking meaningful coordinated action, and this may actually make it more, rather than less, impossible for them to do anything beyond blather while hand sitting.

  3. (This Week with Jake Tapper) Treasury Geithner had little to say or explain that hasn’t been hashed over how many times now since the crisis evolved. Geithner and Obama are two peas in a pod – repeatedly like a broken record (by now) advising us all that if it wasn’t for their heroic bailout efforts, we wouldn’t be standing here today to tell about it – oh pleeeese…. even (some) Conservatives are owning up to excess of Wall Street and the over-reach of Washington by way of lobbying firms and crony capitalism.

  4. They cannot take as much advantage of the euro depreciation as can Germany who really does not need to take so much advantage… now we will see if this experiment with a monetary union before a political union holds up… I expressed my doubts on this in an article published the week the euro was launched though I used Italy instead of Greece as the example.

  5. The weaker Euro is being generated by perceptions of Default Risk, not by monetary expansion. There’s a big difference. That difference is manifested in the 4%-5% rate premium that the CDS markets suggest is being charged on Greek debt, which is of course killing growth. (and that 4-5% may be an understatement since much of it could be owned by greek banks, who are facing asymmetric risks – if greek govt defaults, they’re gone anyway)

    The DEFAULT risk represents a rate premium that Greece is paying to keep its real wages high, which is killing Greek growth and Greek demand for just about everything (not to mention destabilizing financial markets).

    Germany is, in point of fact, using a weak Greece to pull the Euro down to boost its own exports, which is utterly cowardly. Mr. Trichet of the ECB doesn’t wish to actually print some Euros, but he’s OK sacrificing Greece to achieve his objective.

    Meanwhile, Bernanke’s Fed doesn’t dare respond by easing dollars, because he cares more about floating the next US Treasury auction (this Wednesday) than preventing catastrophe. Indeed, the flight-to-dollar helps him sell his bonds.

    Remember, this is the first auction after the Fed ended its emergency liquidity programs (Feb 1), and the MBS program ends next month. Bernanke is more concerned about proving to everyone how wise he is – that the Fed can follow its exit plans as announced. So the dollar-carry-trade unwind is just perfect timing for him. So what if exports stew…

    Sweet vengeance against all those dollar short selling gold-loving nutcases! Besides, he sees his hands as tied by all the short-maturity debt incurred by Dubya, and needs to roll it over before he can inflate (or risk a real dollar flight).

  6. OH, I forgot to mention the really funny part… Greece kicks off a flight FROM the Euro. Some portion of traders moving out of Euro go into dollars, which pushes dollars up. Suddenly, the rest of the world (which is shorting the dollar by borrowing in dollars to buy foreign securities in places like Brazil or Australia) realize they are leveraged on a trade that is moving against them. They rush for the exits as they risk margin calls and liquidity challenges to their carry trades.

    What began as a flight from Greece becomes a rush to the dollar, even though Trichet accurately points out the dollar is not in great shape either.


  7. Whiplash is exactly what our government wants, as long as it is well-timed whiplash. The US government has massive funding requirements that benefit from increased risk aversion, but it is also politically invested in giving the impression of a recovery.

    This probably will not turn out well.

  8. It’s moments like these that I appreciate the play-by-play of those far more familiar with the implications of the plays than I am. Thank you, StatsGuy.

  9. Maybe a stupid question, but couldn’t the Fed just print, say, a trillion USD and use it to buy up euros (or for that matter the yuan) to gain an export advantage? Or is that simply “not done” or otherwise adverse? Inflation doesn’t seem around the corner…

  10. With my very limited knowledge of the economics and finance, I may not be grasping the full implications of the chain reactions you so eloquently narrate here.

    May I ask how China will respond to the stronger dollar – a chance to reduce its TB holdings or the relatively weaker Yuan (assuming the dollar gains strength against it as well) ends up in amassing more dollars via trade? Can they impact the dollar’s strength/weakness in any meaningful way?

  11. @StasGuy, the trigger as you rightly say is the spectre of a Greek default and/or a domino effect on Spain, Portugal, Ireland. As I have argued here before the key issue which was largely ignored by Eurocrats was what happens in the event of a prolonged economic downturn? This was the polemic in 1990s about Political and monetary union, one had to lead the other in the sense that there is no mechanism for joined up fiscal policy and a one size fits all moneatry policy. Per Kurowski points out that Italy was the ” obvious case” then. The fallout will not be contained and wil directly impact on the US both as an exogenous shock and a piling into USD or quite likley gold. We are reaching the end game of this nonsensical fiat money system, so easy to exploit by Governement debasing of currencies. Equally the US has to recognise the limitations of the USD standard, it is killing to US economic interests if a € collapse or weakness drives up the FX rate. We need to graduate towards a serious SDR standard in a multi currency basket possibly including commodities. This was starngles at birth at Bretton Woods as the US emerged as the biggest creditor. That is all ovewr.The UK went through the same nightmare in the 1950s and 1960s, for China read the Commonwealth balances which cause endless £ crises

  12. We live in a globalised world where all have access to the same means and tools to compete in what is running for labour, market shares and the hope for heaps of money.

    While the US very openly seeked an advantage in keeping the greenback at the low side the Chinese just piggybacked their paper money Renminbi to ensure their exports staying competitive which at the same time enables them to massively import labour; the trick with holding more than two trillion soft bucks in cash is not really that bad as those dollars buy access to energy and plenty of shares in i.e. African countries and companies that are used to even weaker currencies.

    What is likely to happen in the not so far future is the EURO, which so far endured and tolerated – of course, lacking an alternative – the dominant but weakening world currency ending is some kind of programmed implosion.

    With Greece more than insolvent, Spain, Portugal, Italy and Belgium not far behind and in general terms very overstressed French and German budgets and economies the once so-called hoard of stability, the EURO, is about to fail dramatically. And if it is not failing in one go we will see it stretched until it does.

    A scenario where one EURO country goes bust has not been taken into any kind of consideration in Maastricht when the artificial currency was imposed not to mention an ugly event where a number of EURO economies are becoming insolvent in a matter of months. What a coincidence, at the same time the once leading and ever so strong economies like France and above all Germany are virtually running out of paper to print the buckets of money they need to bail out or rather pump up banks, run scrappage schemes or fill up tax revenue holes.

    A bursting EURO will automatically open the currencies’ race downwards; the battle to export what is produced and to minimise cost but still put people into jobs is fought at the low end of a currency’s value, see China. With only two plus two major and globally traded currencies left – $, €, and ¥, £ – it will be interesting to see who will win that race.

    I dare say they won’t be any winner.

    Carpe diem!

  13. Simon,

    you are going wrong here. Official talk from Brussels/ECB is hard-line. Inofficially all will be done to build Greece a bridge to walk on.
    You miss two things: 1) Germany is bankrupt too, mostly due to financial losses of state banks, not booked in the budget. But we are talking about some hundred billion US dollars.
    2) ECB can provide the bridge for Greece. But if Greeks use it to flee the country than nothing can help. Capital flight seems to be ongoing. It is a matter of tax policy and law enforcement and credible cutback in state expenditures in Greece. I doubt they will and can do it.
    3) Long term there is not solution anyway to keep the Eurozone together in one currency. You cannot change national character in some years and from outside. We all have to suffer through it. All forward-looking people know that. Why do you want Germans exclusively to finance the in-between and carry even bigger losses in the end? Hey Wall Street (including Deutsche Bank) cheated us already on hundreds of billions – shall we now foot the Greek bill? And then the Portuguese one? And Spain, Ireland, Austria, Eastern Europe ? Can we at least leave the Baltics to Sweden or Russia ?

  14. Yes, to install an artificial currency on a heap of stones would have been more fruitful; it is not to blame the Greek or any other nation; it is the system that was put in place by dump politicians that never listened to the real expert but lived their ego-trip in ignorance.

  15. There has been some talk about the IMF assisting Greece… for all practical purposes, being Greece a member of a monetary union, that would be like California calling IMF… what would the Fed say?

  16. I think you are right – the Fed may let this go for a while just to make currency traders more afraid of piling into an anti-dollar carry trade. That fear would increase the Fed’s range of actions in the future. The Fed has signalled to banks to limit their interest rate risk…

    MW – your guess is as good as mine. China has a controlled exchange rate, but it may use this opportunity to shift more out of Treasuries into gold or other commodities. It announced it was pausing its gold buying when gold spiked a few months back; it may resume buying at some point, but it will surely wait to announce that until AFTER it’s done buying (or else the price goes up). In terms of amassing dollar-based reserves via trade, that’s more dependent on US demand for imports. If that demand stays strong, then China’s cost of goods drops as the dollar goes up, and they keep more as margin. They will continue sterilizing that by forcing banks to use those dollars to buy Chinese bonds.

    The US economy, however, could be brutalized by a high dollar if this sparks another aggregate demand collapse. This is the risk Bernanke is taking to make sure he can fund the deficit.

  17. Germany is, in point of fact, using a weak Greece to pull the Euro down to boost its own exports, which is utterly cowardly.

    This statement is as nonsensical as your previous statements regarding the viability of the US inflating their debts away.

  18. I suppose you mean nonsensical with respect of it being “coward”… because the fact is that the problems of the weaker is keeping the Euro down which in its turn is helping Germany to export.

    And by the way the markets are starting to tell us, in their own spreads, that the real nonsensical part might be to believe that sovereign debtors will pay back their debt, in real terms, based on the sole efforts of taxpayers and economic growth.

  19. Who is speculating against Greece

    It is the time of conspiracy theories, and here is one. Jean Quatremer has obtain information that one large investment US investment bank, and two important hedge funds are behind the attacks against Greece, Portugal and Spain. Their plan is to create panic, and thus to make large amounts of money. He also mentioned that two hedge funds are furious not to have been allotted funds from the recent Greek refinancing.

  20. Germany is not capable, on it’s own, of pulling the euro down to boost it’s own exports. Taking advantage of a situation to help their nation is good governance as is refusing to create a US style moral hazard.

  21. I hope we get a race to the bottom in currency devaluation… Better that than a game of chicken to be the sole surviving reserve currency.

  22. Simon’s getting closer, but he doesn’t quite have it yet.

    The CDS hurricane has hit land again. But the reason is that U.S. Mellonesque liquidation has proceeded so far (now hitting the supply chain–transportation, agriculture, utilities; hadn’t noticed that, had you? but I have–I’m in California), that the hurricane senses that the U.S. economy is now fatally destabilized. Do you think this nonsense with a bog like Europe, would have proceeded if the CDS hurricane had not become aware that the U.S. had just mortally wounded itself? But we have. So there–cat’s out of the bag.

    The CDS hurricane is ambling amiably (is that the correct phrase?) up the economic coast until it hits the U.S. What would speculators do if they knew that the Adminstration is planning a de facto public and private bond default? The template for that is not Greece. The template is what Rahm Emanuel did to the GM bondholders. Look at the terms in which he referred to them. This was the shot across the bow. He will refer to holders of U.S. Treasuries in the same terms. This is the power elite in the U.S. baring their teeth.

    You know those web betting sites where you can bet on anything? They should put one up, listing U.S. Generals, and then inviting you to bet on which one will take over.

    Now Greece DOES provide a template for that! And will again.

  23. In two places you say that the decline of the euro vs the dollar may weaken banks:

    “There may be direct effects on the US, as our banking system remains undercapitalized.”

    Could you explain to a non-economist by what processes this would occur?

  24. So is time to buy Euros with US $’s or wait a few more months?
    I have a trip planned in June. Do you expect ther Euro to continue its downward spiril?

  25. Due to various sensibilities of politcal or economic nature (perhaps polinomic is a better word) there is a lot of smoke blowing around all issues concerning the Euro and especially the credibility of various EU member states.

    Greece looks more like a slaughter lamb in that circle then the epitome of untrustworthy public accounting. Here in Germany, at least between the lines, the press sounds a bit like “ahh those Greek, never should have trusted them, a bunch of crooks like those Romanians”. Viewpoints like that have a long eh tradition and while meaningless where markets and numbers are concerned, they have a lot of influence.

    It doesn’t matter which country has problems as long as it isn’t your own. Most important: you don’t give money to crooks. Especially not after the last bank meltdown in Bavaria with the Hype Alpe Adria and their Balkan business. Especially not while waiting for a not so small election to get brutal with the population about taxes and federal budget problems. Especially not with a government that right now fights public opinion of “worst first 100 days ever”.

    Help Greece? Maybe with an all-inclusive vacation next summer if they keep civil peace but that’s about it. Europe isn’t Europe if there are no ways to “help” Greece without it looking like help but while this may work with some everyday subsidies, a freakin bankruptcy? Nah, until this situation developed it was forbidden to even think in public about any member of the eurozone going belly up – for good nutcase-reason too. That’s why we have those Euro convergence criteria that nobody takes serious in real live.

    Of course only a selected few even wish to help Greece, even with open doors and journalists present. The Greece equation sounds like “Euro + Greece = trouble + where did that come from?”. The role of Greece there is more or less symbolic. It’s the currency, stupid. Still, to argue we will see a D-Mark again anytime soon is perhaps a bit more outlandish then the reality approaching times we live in. Even in a “the game is on” atmosphere there are some things people cling to (not the public, business people).

    Germany wants to cure it’s economy by export of mostly high end comsumer and industrial goods, world export leader and all. Political wet dreams aside the method of choice is called “unit labor cost wonder”, a cheap and at the same time highly qualified workforce (eh wet dream time again). At the same time the domestic market is Germanys weak spot (in some aspects like low private debt a blessing).

    It’s all trivia but it still defines where your currency has to go. In the long run at least from the German viewpoint this develops to the question “How can I sell the largest amount of cars amd powerplants world wide?”. The eu common market is a big part of that, equally because of customers and competitors. The sheer size of it may even start some phantasies of megalomania that no rational human can forsee but still transform into actual policy. From a somewhat sane point of view you don’t sabotage a common currency in an economic situation of mistrust and “race to the bottom” atmosphere. Now if wishes were horses dreamers could ride and the eurozone may even get away with it.

  26. Mr Johnson wrote February 7, 2010 :

    “And if these European troubles start to be reflected in difficulties for leading global banks over the next few days or weeks, the negative impact will be much greater.”

    Monday 8 February 2010 19.58 GMT – – excerpt

    The cost of insuring against a potential default on western Europe’s debt hit a new record as officials failed for a third consecutive day to reassure investors about the ability of southern European countries to pay their bills.”

  27. “The euro depreciates, the dollar strengthens, and our path to recovery starts to run more uphill.”

    A lower valued dollar helps out US exports medium-term to long-term. But, there is another side to that. A temporarily stronger dollar in the SHORT TERM can be a big boost to PCE due to cheaper gasoline prices and the resulting freeing up of discretionary income that helps to relieve budget stresses on the bottom 1/3 of households. The question that I haven’t seen answered yet from any economists are what’s the breaks here? I’ve got a suspicion that our (*long term*) strong dollar policy is the root of the problem. We have opted for cheap gas as a stimulant as long as possible at the expense of everything else.

  28. Yes, it is cheating oneself, no disagreement there at all. But, I think we are in a situation where we are fortunately making oil speculators *lose money* (through a temporarily artificial strong dollar) in order to keep demand (ex-energy) propped up. I recently have read where oil futures are trading at an equivalent price higher than *gasoline* futures (the end product of refining). The oil is getting bought and stored while refining capacity is being shut. This is insanity and it isn’t going to go on much longer. Hello 2008 redoux.

  29. Well if you prioritize fighting oil speculators before giving your citizens job that´s you problem. I would not do that. And besides since the lower that you artificially keep the oil the more you get addicted to it, coming as I do from an oil exporting country, I have no problem with that.

  30. You forgot the Fed, which will drive the dollar down to support US exports. What drove the Euro to 148 in the first place? It is still an open question whether an ocean of electronic money can prevent collapse of the latest thing regarded as a strong asset in the hedge fund universe. I suspect publicized attacks on the Greek social contract will produce miraculous recovery of Greek bonds. Think Mexico, Argentina, 1982.

  31. You could have made the same arguments in 1982. The fact is that fiat money creates a traders’ world. Traders know the price of everything, the value of nothing. Expect prices to fluctuate, endlessly, while govt lackies apply lipstick to the pig and corporate poobahs prattle about deficits and shareholder value and stampede toward monopoly. The problem is political. Either we control these people or they control us. The middle class has simply run out of wiggle room. Veblen explained all this in 1904.

  32. This could have been predicted by anyone at inception of the Euro. What the corporations are after is one common European government, controlling all the decisions now left to individual countries. Hitler wanted the same thing. Plus que ca change….

  33. Wait. Aren’t the US’s biggest trade partners outside of Europe? Didn’t European currencies weaken in the 1990s as the US economy expanded? I realise I’m over-simplifying a little here, but how correlated is a weak euro to a big US trade deficit – really?

  34. It’s not necessarily nonsensical, considering that the EU is (supposed to be) a political union. If Germany is allowing it’s already greatly indebted partners to get deeper into debt due to the high risk premiums they’re paying by refusing to support them so it can speed up it’s own recovery, the question of what kind of union the EU is obviously comes to mind as does the question whether Germany is very happy to enjoy the benefits of the EU and the EMU without it’s downside.

    Please don’t give me the “they deserve what they got” line. Even if we forget the issues of trade imbalances and assymetric shocks in a currency union, which make the situation the eurozone is in today totally predictable and in fact predicted by various economists, the “we’ve been deceived by Greece” line parrotted by various EU officials is pure hypocrisy. Maybe they shouldn’t have allowed Greece into the eurozone in the first place but now they have to deal with the fact that they did. Or kick them out and let the IMF take over. Greece has been running high debt-to-GDP ratios and budget deficits for decades and if the EU didn’t have either the mechanism or the will to impose fiscal responsibility on Greece it has to take part of the blame for the debacle.

    Anyway, recent events make me believe that although Germany certainly benefits from the situation they will not allow it to continue for very long. Already the rumours for a greek bail-out are becoming stronger and the bond spreads decline. As this coincides with the announcements by the greek government of austerity measures and the new tax code it is probable that political pressure to the greek government was at least part of the “we will not bail Greece out” tactic used up to now.

Comments are closed.