Are We on the Cusp of a Currency War?

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During his presidency, Donald Trump has taken on friend and foe alike — often with equal vigor — if he believes some degree of unreasonable behavior has been going on to the detriment of the U.S.
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The E.U. has experienced its fair share on that front: tariffs on steel and aluminum (along with much of the rest of the world), threats to the automotive industry (particularly the German car industry) in the form of heightened tariffs and threats to pull out of NATO if Europe doesn’t pay its way.
So far, much of the aforementioned has proved to be bluster. Subsequent negotiations have watered down some of the threats and/or postponed implementation to allow for some form of a negotiated settlement.
But according to a report in The Telegraph, the latest object of the administration’s ire could result in a much more serious breach between the old allies.
That the Euro is undervalued and the dollar relatively overvalued is no secret.
That both are where they are, it has to be said, is also not due to one or two simple actions but to a combination of circumstances — some deliberate and often coming with both intended and unintended consequences.
The dollar, for example, has hit a 17-year high, according to the Federal Reserve’s broad dollar index, The Telegraph reports. Trump’s tax cuts came at the top of the cycle and pushed the budget deficit to 4% of GDP, encouraging the Fed to prematurely raise rates last year.
Meanwhile, the manufacturing trade deficit has ballooned to $900 billion as U.S. manufacturers struggle against a strong dollar and the imposition of import tariffs raising raw material costs. After an initial boost, this is now having a toxic mix of depressing economic growth while holding up the dollar, making an export-led recovery harder.
The Euro has gone in the opposite direction.
Quantitative easing (QE) has depressed the Euro for the last five years. The trade-weighted index fell 14% a year after Mario Draghi, president of the European Central Bank, signaled bond buying was coming in 2014. That has been a powerful stimulus, such that Germany is now running a current account surplus of 8.5% of GDP and Europe as a whole is running a surplus of $300 billion-$400 billion per annum.
Since QE stopped last year and hastened by a slowing China, growth in Europe has slumped; the ECB is desperate to get it going again.
But the ECB will have to be a lot more radical than it was with previous measures.
Yields on 10-year German Bunds are -0.3%, in the paper’s words, and the bond markets are signaling an ice age. Inflation expectations — and, by association, growth — have collapsed, but the ECB will have to get radical if it is going to achieve any impact, which will be seen as currency manipulation in Washington (a position that, for once, lawmakers on both sides can agree on).
The president will have plenty of support for retaliatory action.
The article suggests one measure is playing Europe at its own game. The Economic Policy Institute in Washington proposes buying the bonds of any country engaged in currency manipulation to neutralize the effect by driving up the value of its currency (in this case, the Euro). Used in conjunction with the president’s favorite approach of slapping on tariffs, the most likely target being cars, that type of response would have a deeply damaging impact on the European economy.
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Battle lines are being drawn — all eyes are now on the ECB’s next move.

One Comment

  • Similar objections to currency management have been lodged by Ruchir Sharma of Morgan Stanley. Wall Street loves a strong dollar, and it is bad for American Workers and main street firms. See my response to his objections in this tweet:
    Europe has severe structural problems related to the absence of a common fiscal policy, as noted by Paul Krugman, Joe Stiglitz and others. See Stiglitz book on “The Euro..” Europe needs to get its own fiscal and monetary house in order. It’s not our problem.


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