The situation in the euro zone has become so bleak that it is giving rise to the most improbable rumours. The latest to make the rounds of European hedge fund managers suggests that the euro will be tied to the dollar at close to parity, a dramatic fall from its current level of just under $1.30 and one that would involve the printing of hundreds of billions of euros.
However unlikely, the speculation is an indication of Europe’s plight in a world with little growth and every government looking at exports as a way to grow. A cheap currency giving an artificial boost to competitiveness is more palatable than austerity.
The euro remains relatively strong for a variety of reasons. Despite domestic tensions, Europeans are not taking their money out of Europe, they are just moving it to safer homes within the region. Moreover, European banks continue to sell off dollar assets and bring the proceeds home. In addition, central banks in emerging countries continue to hold the euro as something of a reserve currency.
Meanwhile, the Americans and Chinese prefer to see the euro remain strong since exporters on both sides of the Pacific compete against Europeans. To the extent that the euro does drop, pressure will increase on the Fed to consider another round of quantitative easing to keep the dollar relatively depressed.
If the euro collapses that will be especially bad news for China though, since 18 per cent of China’s exports go to Europe. In April, Chinese exports to the euro zone were down 2.4 per cent from a year ago, according to broker CLSA. Some of those exports were from German makers in China itself. For example, Pakistani textile mills have recently imported capital equipment from Siemens plants on the mainland. But if the euro sinks, German manufacturers will export from home rather than from their Chinese factories.
Some analysts suspect that China has been trying to support the euro and indeed, data from BNY Mellon suggests that as the growth in Chinese reserves slows, the euro falls.
Meanwhile, the liquidity from the excess printing of money especially in the U.S. continues to spill over into the rest of the world.
Since the crisis, once again liquidity stemming from the U.S. has driven commodity prices up and helped stoke credit booms in many emerging markets such as in Brazil.
That means that while the markets continue to focus on the euro zone and its troubles, there are other longer term conflicting trends in the currency world that bear watching. They stem both from these flows of developed market liquidity and from the latest economic developments in China.
China reported disappointing trade numbers this week with exports and especially import levels far lower than expected, pointing to lower growth. But more importantly, analysts such as Stephen Jen, of London-based hedge fund SLJ Macro Partners and formerly the head of currency research at Morgan Stanley, believe that China is undergoing a major shift in the sources of growth, tilting away from investment-led growth to a more consumption driven model.
That also raises the stakes for the U.S. and increases the likelihood of another round of easing from Washington.
In recent months, exports – especially to China – have been one of the few sources of growth for the US but that growth is slowing now, with some companies seeing slower orders. On Thursday, the U.S. Commerce Department reported that the trade deficit widened $6.4 billion to almost $52 billion as imports rose 5.2 per cent and exports rose 2.9 per cent.
That also means countries that have ridden China’s coattails such as Brazil and Australia may see their own fortunes turn down since consumption-led growth is far less commodity intensive than investment led growth.
No country was more of a beneficiary of the liquidity from the developed markets and demand from China than Brazil. But today, many analysts consider the Brazilian real to be the most overvalued currency. A world in which commodity prices are significantly lower may mean that commodity importers will do better in coming years.
The central banks of the developed world cannot print money indefinitely. When they stop, it will be the countries that have used the time and money to become truly competitive that will be in the best place.