Home » Currency War » Welcome to the Currency War, Part 2: Massive Euro Devaluation

Welcome to the Currency War, Part 2: Massive Euro Devaluation

by John Rubino on June 28, 2012 · 32 comments

As everyone knows by now, Greece, Spain and the rest of the PIIGS countries can’t fix their economies because they can’t devalue. If they were still using their old national fiat currencies, so goes the conventional wisdom, they could just mark them down by 30% and instantly see their exports surge and their deficits shrink. Et voilà, they’d once again be fully-functioning members of the global economy.

But the euro is beyond their control, leaving them with only austerity, which in this context is another word for Depression. Hence all the speculation over radical-but-suddenly-conceivable ideas like a Greek or Spanish exit, fiscal integration with Germany in charge, and eurobonds guaranteed by the eurozone as a whole.

This is all wasted effort, however, without the final piece of the puzzle: The ECB will have to flood the system with newly-created currency, which is another way of saying that the euro itself will have to be devalued.

Acknowledging this inevitability, Martin Feldstein, Harvard professor and former chairman of Ronald Reagan’s Council of Economic Advisers, calls explicitly for a euro devaluation in today’s Street Journal:

A Weaker Euro Could Rescue Europe
Devaluation is the only way to save the single currency.

The only way to prevent the dissolution of the euro zone might be a sharp decline in the value of the euro relative to the dollar and to other currencies. European politicians’ dreams of political union and permanent fiscal transfers are not realistic solutions to the multiple problems of the euro zone’s peripheral countries—especially on the tight schedule needed to halt the collapse of the single currency. The European Central Bank (ECB) may continue to provide additional liquidity, but experience has already shown that it cannot reduce sovereign bond yields to sustainable levels.

The peripheral countries—Italy and Spain, as well as Portugal, Ireland, Greece, Cyprus and perhaps others—can only remain in the euro zone if they solve four difficult problems. First, fiscal deficits must be permanently lowered to reduce the interest rates on sovereign bonds to levels that can be financed in the long run. Second, economic growth must be revived to create employment and sustain political support for that fiscal consolidation. Third, commercial banks must be recapitalized to stop the deposit runs and preserve lending capacity. Finally, large trade deficits must be eliminated so that these countries are not permanently seeking transfers or loans from foreign creditors.

Politically difficult decisions could solve the first three of these problems. Less government spending and higher taxes could reduce fiscal deficits. Changes in labor laws and other institutional barriers to productivity could produce stronger economic growth. And sufficient growth would give governments the fiscal capacity to recapitalize their commercial banks.

But implementing these policies would not solve the fourth problem: the periphery’s staggering trade and current-account deficits. Those deficits reflect the peripheral countries’ lower competitiveness after a decade of slow productivity growth compared to Germany and other northern euro-zone members.

If the peripheral countries were not locked into the euro but had their own individual currencies, they could follow the strategy of combining devaluation and fiscal consolidation that has been successfully adopted by countries in Latin America and East Asia and more recently by Britain. Devaluing currencies would boost exports and reduce imports, simultaneously eliminating trade deficits and spurring growth. Higher GDP would offset the depressing effect on aggregate demand caused by the higher taxes and reduced government spending needed to eliminate the fiscal deficit.

This route out of the trade and current-account deficits is not currently available because the members of the euro zone are locked into a single currency. That’s why euro-zone officials argue that member countries must force wage levels to decline under the pressure of unemployment so as to achieve “real devaluations” of as much as 20%. But even with persistent unemployment rates of more than 20% in Spain and Greece, there has been little progress in reducing real wages. A strategy of massive real devaluation through high unemployment is simply not feasible in democratic nations.

This structural impasse could be bypassed if the peripheral countries left the euro zone, returned to national currencies and devalued. But that dissolution of the wider euro zone could be avoided by a substantial decline in the value of the euro versus other non-euro-zone currencies. Euro devaluation would not change the trade imbalances within the euro zone but would increase the global exports of the peripheral countries and decrease their imports from non-euro-zone nations. This in turn would raise the GDP of peripheral countries, allowing them to achieve positive growth while also reducing fiscal deficits.

A weaker euro would also render German products even more competitive in global markets than they are today, increasing Germany’s already large trade surplus with the rest of the world. Increased demand in Germany might put upward pressure on German wages and prices. But the net effect would be an even stronger German economy.

Although a decline of the euro would mean higher import prices in euro-zone countries, it need not mean higher inflation or even a higher overall price level. The ECB could in principle continue to aim at a 2% inflation rate with lower prices of domestic goods and services offsetting the higher prices of imports from outside the euro zone. At worst, the ECB could allow a one-time pass-through of the higher import costs but prevent any further increases in inflation rates.

A one-time fall of the euro that eliminates the current-account deficits of the peripheral countries would not solve the ongoing competitiveness problem caused by stronger productivity growth in Germany and other northern countries. But a combination of policies that accelerate productivity growth in the periphery and slightly slower wage increases there would prevent a return of large current-account deficits. Eliminating today’s large current-account deficits would make small annual adjustments in the future feasible.

A major decline of the euro does not require explicit action by the ECB or other euro-zone institutions. If major global investors in euro bonds conclude that there will be either a breakup of the euro zone or a sharp decline in the value of the euro, they will reduce their holdings of euros, driving down its value. In that way, the bond market may by itself deliver the conditions needed to eliminate the current-account deficits of the peripheral countries and prevent the dissolution of the euro zone.

Some thoughts
Let’s put it bluntly: devaluation is theft. When a country borrows too much and then marks down its currency it is stealing from its savers and the trading partners who were naïve enough to think the currency was a trustworthy store of value. So calls for the eurozone or anyone else to devalue rather than live within their means are simply enabling the breaking of what should be seen as a serious promise.

Devaluing the euro will absolutely smooth the integration process — for about two weeks, until the US, Japan, China, Brazil and all the other trading nations that are hurt by a falling euro retaliate with devaluations of their own. Then we’re in Jim Rickards’ Currency War III (the first two happened during the Depression and in the 1970s), complete with rising volatility in prices, interest rates and pretty much everything else.

Feldstein: “Although a decline of the euro would mean higher import prices in euro-zone countries, it need not mean higher inflation or even a higher overall price level. The ECB could in principle continue to aim at a 2% inflation rate with lower prices of domestic goods and services offsetting the higher prices of imports from outside the euro zone. At worst, the ECB could allow a one-time pass-through of the higher import costs but prevent any further increases in inflation rates.” Oh yeah, right. Central banks have absolute, razor-sharp control of capital flows enabling them to decide which categories of prices will rise or fall by how much. Strange that these omnipotent beings allowed today’s troubles to happen in the first place…

Anyhow, one of the guaranteed results of a currency war commencing with today’s stratospheric debt levels and systemic fragility will be capital controls of a variety and scale never before seen. Each combatant will try to trap its citizens’ wealth at home in order to confiscate it through inflation, taxation or direct expropriation. So geographic diversification is more important than ever.

{ 27 comments… read them below or add one }

Bruce C. June 29, 2012 at 1:37 am

Yikes! Am I the only one left around here? Hello out there…

First of all, before we all get too excited, allow me to remind you that Martin Feldstein is just another Halloween character that has been paraded before us before, most famously as a potential Fed chairman. His calling card was to devalue the US dollar CONSISTENTLY (no more undershoots!) at 2% per year “to keep it strong”, and that was back in the 90’s.

So, why am I not surprised that he says, “Devaluation is the only way to save the single currency.”?

Imagine if he were your doctor: “Amputation is the only way to save your body.” Or, your psychatrist: “Mental retardation is the only way to save your mind.” Or, your gardener: “Replacement with weeds is the only way to save your landscape.” Are you still with me?

Good. Look, maybe the guy is trying to recover from a rough divorce or something but, please… Notice that he can’t even hold a conviction for more than 5 seconds. His very next sentence is a wimp out, ” The only way to prevent the dissolution of the euro zone MIGHT BE a sharp decline in the value of the euro relative to the dollar …” (Emphasis mine, of course.) Pathetic. But get used to it.

Okay, let’s review some 2nd grade arithmetic. If a bond pays, say, 7% in “euros” with a certain amount of purchasing power in 2012, will a bond that pays out euros worth 50% less in purchasing power next year be required to pay much less than 7%, or much more? Let’s ask the Marty Calc: Much, much more! Whoa!!! So why is everyone so upset about Spain and Italy having to pay 7%?

You get the idea. But I’m gonna stop now so I don’t jinx this site like I may have at the last post.

Oh, and remember to diversify so you don’t sleep too much.

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Agent P June 29, 2012 at 4:49 am

When do the coordinated central bank $efforts (ground war) start…?

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tomt June 29, 2012 at 5:43 am

Nothing mentioned seems to extricate the true sources of these societal woes,
and regardless of the medicine prescribed, it won’t really end by treating the symptoms. This is like a movie to many who are content to watch it til the end, and continue to support “their party” long afterward.
Although this does set up like “Currency Wars”, I am hoping events somewhere shift enough of the public out of their complacency soon. Remember Iceland!

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Sue July 16, 2012 at 3:20 am

Iceland is full of Vikings. America is full of sheep.

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Jason Emery June 29, 2012 at 12:44 pm

Once they made the decision to do everything in their power to keep bank bondholders whole, the devaluation of the Euro became a matter of when, not if.

If you people had studied Mises, you would not be surprised by this outcome. The only thing that could possibly prevent a severe devaluation of the Euro is if someone invents a time machine and they go back and prevent the inflation of the bubble that is currently deflating.

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Steven G June 29, 2012 at 1:39 pm

>> Those deficits reflect the peripheral countries’ lower competitiveness after a decade of slow productivity growth compared to Germany and other northern euro-zone members.

I think those deficits also reflect what happens when the IMF encourages policies in emerging economies which reduce self-sufficiency. The IMF actually proposes NOT growing food for local consumption, but growing cash crops instead. This sets the stage for the small nations to not be able to feed themselves. Also, these crushing trade deficits could be globalization’s version of “I owe my soul to the company store”.

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paper is poverty June 29, 2012 at 3:58 pm

A friend from Greece reports that when they joined the EU, burdensome over-regulation (of the sort Nigel Farage has described) destroyed many small business owners. Certain exports (especially olive oil) were encouraged, but surpluses quickly followed, and plunging prices bankrupted many farmers. To hear this guy talk, Greece has been falling into a Depression starting with the moment it joined the EU. And now they’re blamed for slower productivity growth.

It also seems unreasonable to expect an economy based on tourism and agriculture to show the same productivity gains as a heavily industrialized economy like Germany’s, where technological advances continually boost productivity. I think Greek farmers pretty much know how to grow olives… I don’t know where the big productivity boost is supposed to come from.

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Richard H June 29, 2012 at 1:57 pm

Why not devalue everything against Gold? Or, since many of the Euro countries have large gold reserves, revalue gold across the board and use it to pay off the debts.

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jay61050 June 30, 2012 at 10:12 pm

Devaluing eveything against gold is , of course, the only solution to the problem. The only trouble is that this is an idea whose time has not yet come. Once gold has been revalued so that the bondholders can be given the option of being paid off in gold , or keep receiving interest and payment in printed currency,then soverign countries will have excellent balance sheets. The price would have to be revalued high enough so that the debts can be paid with the gold on hand. In the case of the USA we are reported to hold 280 Million ounces, dividing that into the bonded indebtness of around 15 Trillion gives you the price gold would have to be set at. Once you arive at this price for gold why not then double it so that there will be an extra cushion for the government to pay for social programs the next following years. The winners in all of this would be the individual indebted nation states and the vast bulk of their population currently facing “austerity”. The losers would be investors who had not already properly hedged their portfolios with a gold representation. Those who had hedged their portfolios would benefit even more than everyone else.

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Pete June 29, 2012 at 3:29 pm

I was just going to say stupid. But I guess I’ll reconsider and just say uninformed and stupid.

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Paul Blumenthal June 29, 2012 at 9:30 pm

Gold Price Chart so beautiful it will make you want to lick your screen. Updated live in 26 currencies: http://www.sh1ny.com.

Paul Blumenthal,
http://www.sh1ny.com Founder

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OBSERVER June 29, 2012 at 9:52 pm

Why is Germany more productive than Greece? What makes the Greek people different from the Germans?

It is latitude?
Temerature
Humidity differences?

Please. There HAS TO BE A REASON since it is absolutely factual that there IS a DIFFERENCE?

The Greek population as a whole is different from the German population. Their cultures are different since culture is created by the “people” of that are. So, this can only mean there is a DIFFERENCE.

Could it be intelligence? Ever look at different dog breeds? They look different. Greeks look different than Germans. That is as obvious as the way a poodle looks different from a Great Dane, but they are still “dogs” but of different breeds.

The Greeks are a different human breed than the Germans.

Just as dog breeds LOOK different, they also BEHAVE different. Not so? This will mean that the Greek human breed will behave different than the German human breed.

Thus…………………….the answer is “race”.

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paper is poverty June 29, 2012 at 11:08 pm

At the risk of feeding the trolls and coddling silly people–

You are confusing selective breeding with natural selection. Humans are not bred and thus “breeds” is a ridiculous term to apply to people. As a result of your mistake you have a grotesquely exaggerated view of genetic differences between human cultures.

Secondly, culture is not determined largely by genetic differences. Do you think nobody ever looked into this before? Geography, history, contact with other cultures — hello? Medieval European culture was massively changed by a simple bacterium in the 14th century. The world is actually pretty complex, maybe you should come out from under your rock once in a while and read a book.

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OBSERVER June 30, 2012 at 2:13 am

Ok, the correct term is “sub-species” but I was trying to avoid that since the vast majority of people have no concept of genetics or even what this means.

The Greeks of today are vastly different from those of 2,500 years ago where just about every pictorial display shows a different “looking” people. They looked “germanic” 2,500 years ago.

During that time there was breeding differences and genetic drift from the original Greek population. With whom? Mediterranean tribes. This CHANGED the genetic makeup of the original Greeks, thus changing the behavior, temperment and innate character of the Greeks. Thus, the culture we see is DIFFERENT from the different Greeks that lived 2,500 years ago.

It is called evolution. I just used “breed” in place of “sub-species”.

Genetics is the dominant “cause” on behavior and behavior determines “culture”. Greeks are NOT the same as Germans.

Then, you explain why the Greeks and Germans don’t have similar cultures? Is it the amount of sun? The curve of the Earth?

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paper is poverty June 30, 2012 at 4:12 am

Why don’t you say Aryan when you mean Aryan so we all know where you’re coming from.

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Jason Emery July 1, 2012 at 5:17 pm

observer said, “Genetics is the dominant “cause” on behavior and behavior determines “culture”. ”

The facts don’t back up up. When you cross the border from San Diego to TJ, Mexico, there is a dramatic change in culture, even though Mexican ‘race’ people make up 1/3 of the population on the north side of the border.

And this ‘dramatic change’ persists all the way to the southern tip of Chile/Argentian, almost half way around the world. I can assure you that there are vast racial differences along the way from northern Mexico to Antarctica.

A lot of factors go into ‘culture’ and language is by far one of the most important, and you didn’t even mention this.

Another important factor, in my opinion, is the length of the growing season. the shorter, the more nature forces the culture to adopt a ‘saving for a cold day’ mentality. If you don’t have this mentality, how does your ‘race’ do you any good in the middle of the Winter, lol?

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Sue July 16, 2012 at 3:22 am

The Greeks were developed a LONG time before Germans. Things change, that’s all.

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paper is poverty June 30, 2012 at 3:58 am

Why don’t you say Aryan when you mean Aryan so we all know where you’re coming from.

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OBSERVER June 30, 2012 at 1:44 pm

I don’t understand. I wasn’t even talking about ATLAS SHRUGGED.

I was trying to find out why there is a difference between the Greeks and the Germans. Perhaps you can tell me?

If it is language, then every nation should switch over to German and thus gain the economy and higher standard of living that comes with speaking German. Ok?

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paper is poverty July 2, 2012 at 2:16 am

I wasn’t referring to Atlas Shrugged, I was referring to the Nazis. It was their theory that the ancient Greeks were more Aryan (Germanic) than today, and that many of their accomplishments were attributable to Aryans who had traveled south into Greece. According to the Nazis the Greeks subsequently went downhill as a people due to mixing with Moors.

Have any original ideas?

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Sky Dude June 30, 2012 at 6:30 am

Observer does have some valid points, even if they are politically incorrect. But this problem requires objective analysis, not bleeding-heart liberal analysis.

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OBSERVER June 30, 2012 at 5:31 pm

Sky Dude, thanks for civility.

I have lived in Europe. I even lived in Beirut, Lebanon. I was basically raised in Europe and it is common knowledge that the more North you go the more “civil”, industrious and wealthy the culture.

Why is this? Even if you take a bunch of Greeks or Italians and put them in a major North European city, they still show the culture of Greece or Italy.

Why is this? I remember traveling and taking home-grown Americans around. We would talk about how much safer it was in Denmark and Switzerland but then how women had to be far more careful in Italy and Spain.

Why is this? Culture? Well, WHY is there a difference in culture? Why do Italians look different from Swedes? Why?

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paper is poverty July 1, 2012 at 1:21 am

Right, Switzerland… I think they fully granted women the right to vote (in all cantons) in 1990. Definitely very forward thinking.

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Francisco L July 24, 2012 at 9:52 pm

Since for you it´s all a question of race, maybe you, with all your superior intelligence, can answer why northern women prefer Latin men. Those men with golden tanned skin ,sculptural oiled bodies, shining under the sun, near the sea in a desert beach.
Or maybe it is because they just don’t give a shit about your racist boring talk. Maybe they are dreaming for a real Latin man, while you are here writing bullshit.
So if your mother, sisters and wife prefer Latin men and its not because their intellect or culture then the cause is certainly anything else.

I’ll give you a hint; size, hardness and manhood.

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Wm of the High Desert July 1, 2012 at 4:24 am

I’ve been to several black occupied Caribbean islands. Some were rather scary for this lilly-white guy because of my survival concerns; but not Bonaire: those guys in dreadlocks in the bar in the dark alley at 2am there were really very polite and generous. That night I learned it’s not subspecies: it’s culture. As far as blacks go, stay away from Somalia and its culture, but do try Waya Island off of Fiji, Waya’ns are super sweet gentle melanesians, they struck me as being very thoughtful. It’s culture that comes from parents, lack of parenting, chiefs, government nannying and brainwashing, etc. It’s culture.

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QQQBall July 1, 2012 at 3:13 pm

’bout sums it up:

Anyhow, one of the guaranteed results of a currency war commencing with today’s stratospheric debt levels and systemic fragility will be capital controls of a variety and scale never before seen. Each combatant will try to trap its citizens’ wealth at home in order to confiscate it through inflation, taxation or direct expropriation. So geographic diversification is more important than ever.

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Paul Blumenthal July 5, 2012 at 8:25 pm

Current system is fascism. That’s true. But true free market economy always finishes as fascism (corporationism). That’s something that you guys don’t see. Let me give you an example:

It is 1998. Nobody heard of web search, right? I don’t think that the term was even defined. So, obviously as nobody knew what it was, there was no Government regulation or intervention in the web search market, right? So, we have 1998 and we have 2 guys in a Garage creating Google. And thanks to the lack of regulation and lack of the Government intervention Google works out beautifully. So far so good. We have 100% pure beautiful capitalism for Google. Everybody happy. Capitalism at its finest. Now comes the part that is explained by Marx and you guys simply don’t grasp: In the year of 2010 Google sponsors a bill to regulate the market economy so its position as a monopoly for web search is secured by the law. That’s the fact bill like this has been developed by Google. Now Google bribes (aka ‘lobbies’) the House/Senate/etc and gets what it wants: if you use Google connections goes through fat and fast Internet connection. If you use something else, no matter how many times better, the law says that slower connections must be used. That’s exactly right. That’s fascism: laws created by corporations to secure their monopolistic positions at the same time empowering Government more as now it needs to eavesdrop only Google’s traffic. Everybody wins. Except for constituency that is. Fascism. In other words once those corporations grow big enough thanks to the lack of regulation and free markets THEY will regulate instead of the Government (democratically elected Government I should add).

And I know what will you say: “Ahh.. it’s still because of the GOvernment because the Government enables this. Because the GOvernment allows bribing and lobbying to happen”.
Well, this argument is aking to communists argumentation that communism would work great if just people could understand that they ought to be equal and not want more than their neighbor. It is the same stupid logic: oh capitalism would work great only if these stupid people would understand not to take bribes, lobby and have no special interests. It is utopia my friends. Politicians will always accept fact checks from corporations. This way corporations ultimately destroy capitalism that created them and replace it with corporationism known also as fascism. That’s the path that not only Google took, but also banks in the past – hence FED was created to secure their interests in 1917. Big Pharma, hence MedicAid and Medicare were created. And military complex hence all the wars.

You see capitalism is self-destructing. So go there and read Marx before dismissing him as an idiot.

Paul Blumenthal,
http://www.sh1ny.com Founder.

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