The Currency War is moving from a war of attrition to a much hotter war.
The recent elections in Greece, France, and Germany showed that Europeans are getting tired of talk of austerity and instead want growth.
On one level, they are right. All of the solutions to the Euro Debt Crisis have been focused on reducing government spending and raising taxes. In fact, it is very important to reduce the government’s share of the economy because that is where the debt is being piled up. The debt has reached unsustainable levels in many countries and only reducing spending can there be a possibility that the debt will not continue to grow.
Many countries have been promoting the idea that raising taxes is necessary to balance the budget. Nothing could be worse in this environment. It is an economic truism that raising taxes on something reduces whatever is being taxed. Thus raising taxes on income will result in less income in society.
This then leads to a vicious cycles of reducing tax income which causes more calls for even higher taxes which leads to less income and so on.
It would be better to lower taxes to increase the income in society which then leads to higher tax revenue to the government which helps to reduce the debt of the government.
The problem with the current rhetoric is that governments, led by France and possibly by Greece, want to also devalue the euro. They will put increasing pressure on the European Central Bank (ECB) to ease further to help devalue the euro.
As my friend Philip Wittmann said, there is nobody in Europe that doesn’t want to see devaluation. Increasingly, we are seeing rhetoric that devaluing the euro is a key part of the plan to get Europe back out of the crisis.
The recent G-8 meeting had the President of the US pushing Europe hard to go to “pro-growth” policies which will give the Europeans air cover to devalue their currency.
Actually, devaluation does nothing to increase an economy. The cheaper currency helps exporters export more so they are happy. But all imported goods, including oil, become more expensive which means that fewer of these goods are bought thus reducing the economy. Basically a wash.
In addition, inflation increases when a country devalues which then causes the central bank to tighten which reduces the economy further. In other words, the devaluation actually harms the totality of society but helps exporters.
Nonetheless, the prevailing orthodoxy, lead by the International Monetary Fund, and blessed by all major governments is that devaluation will help boost an economy.
The desperation of the Europeans means that they will now be more aggressive in devaluation.
Look for the euro to go to parity with the dollar over the next couple of years. Sell euros.