We have not heard from Howard Jones on the Foreign Currency markets for a while, as the story of dollar strength seemed pretty unyielding, but we do sense that a turning point is at least back on the table.
"Europeans have long
been envious of the reserve currency status of the US dollar. The often quoted
lament of French president Giscard D'Estaing of "America's exorbitant
privilege" revealed a desire to somehow undermine that position.
Reserve currency status indeed brings advantages, which most of us are familiar with. But it also frequently leads to over valuation, encourages borrowing and debt via lower rates (exacerbating boom and bust) and may lead to global events influencing monetary policy, instead of the usual purely domestic considerations.
The desire for reserve currency status was certainly part of the Euro dream. Brussels has long wished for an upsurge in Euro holdings, a sign of virility and confirmation that their dream is unfolding. So how has it done?
Here is a graph of global euro reserves.
In essence, it's gone nowhere and it's unlikely to do so, until we see a fully integrated fiscal policy, within the Euro zone. That means a Euro zone debt market, and a common bank deposit insurance scheme. It means a pooling of revenues and liabilities. As it stands the European Project is half finished. It's in No Man’s land, neither one thing nor the other.
Without full fiscal integration the Euro will remain a flawed concept. How you get that radical change past Berlin is the real challenge, because Germany is the real winner from the current arrangement.
See the graph below to see how.
This graph sums up the instability of the Euro zone. Since the introduction of the Euro, the German current account surplus has gone from basically flat to 8.5% of GDP. Look at this chart of current account surplus against GDP.
Let me repeat that extraordinary number, 8.5%.
So, which nation epitomises a mercantile approach to trade, hiding behind a weak currency, "stealing" our jobs and upsetting international partners? China is of course the perceived bogey man. Take a look at its actual trade surplus, in dollars this time.
Which shows a very different trend and a similar size surplus, despite representing a much bigger economy (over three times the size) than Germany.
To borrow a phrase, "Not Good". The White House clearly has the EU in its sights, Germany in particular. And this is at a time that the Euro zone falls ever further into a deflationary spiral, with the European Central Bank scrambling to find its way out.
Draghi the ECB president, last week in Sintra, made it clear he will (once again) do anything in his power to fight off this deflation. Will more Quantitative Easing follow? Will the Germanic block countenance it?
And indeed is it effective?
There is a school of thought that argues that the stimulus from QE is all achieved via currency devaluation.
And this is where the eye of the White House is watching. Any attempt to drive the Euro lower will be met with indignation from the USA. ‘Beggar thy neighbour’ has become the covert policy of Germany since the introduction of the Euro. They are a major destabilising force within Europe, but also on a global level.
German efficiency is a myth as anyone with direct experience of its frequently dire infrastructure and archaic financial services sector knows. German currency manipulation is its secret ingredient. With regard to trade, they are part of the global problem.
So where does the ECB go next?
Rates are negative. A weaker currency will incur the wrath of Trump, and you can be fairly confident, if nothing else from him, that tariffs will follow.
Is massive fiscal stimulus an option, perhaps with a growth and stability pact as a central ingredient of the EU policy? Many would love it, both Macron and Salvini for instance. But no chance, that duo will most likely not agree on the time of day.
The Euro Zone is locked in a Vice. Every which way the ECB turns they will be thwarted.
Germany needs either to commit to fiscal union, absorb and pool all national debts, and issue joint bonds and indulge in massive fiscal transfers. Maybe then part of that "exorbitant privilege" will become a reality.
Or it needs to leave the Euro and go back to the Deutsche Mark. That would liberate much of Europe, including those stagnant client states to the East, restore normal trade balances, and reduce international tensions both within and outside the EU.
If this comes about partly because of pressure from the White House, much of Europe may just be thanking the Americans again for re-establishing the balance of power within their continent, the ultimate economic irony created from political dissonance.
But no, it is not something we expect to happen. If nothing else it would be an odd reward for fiscal prudence. But we do sense this stalemate can’t last a great deal longer in the absence of decisive action. In valuing the Euro that underlying tension should not be forgotten.
Event Risk FX Ltd
More information about the relative currency valuations of Germany and China are to be found in this paper. This is based on their current account positions and the degree of misalignment – visualised.
Here is the crucial graph from this paper:
This week Howard Jones looks at what has become a major challenge for fund managers this year, namely the sharp gyrations of sterling.
Where performance is measured daily and sterling is the base currency, it is becoming a true test of skill in hedging, for international investors.
The high drama of U.K. politics has been riveting. If this were a soap opera, and there are certainly similarities, the script requiring a Grand Finale, or indeed an additional season, could not have been better written. The set is strewn with bodies, the boss held captive by secretive powers, hungry lieutenants jockeying for power, revolutionaries at the wall (well on College Green), the money man a flitting shadow paying off all and sundry. And the ideal cliff hanger scene (https://www.rte.ie/news/analysis-and-comment/2019/0315/1036688-backstop-deal-cox/) is set, with old clan leaders in the background now in the pay of foreign states, elderly cast members struggling through the series, and others waiting to be written out before the next season starts, if they still can't agree on their excessive pay.
Sterling has consequentially been the most volatile currency, with an overall solid gain as the fear of "No Deal" gets priced out.
To see MPs back a motion to seek to block no deal under any circumstances, was confirmation that most of our representatives have no idea about negotiating.
If you ever wanted justification for rejecting the short termism, opportunism and populism of representative democracy, this was it.
Politics have a huge bearing on currencies. Markets tend to extrapolate events, probably to exaggerate their significance. Then those with foreign exchange exposures, who have not been paying attention, are forced into trading decisions, thereby extending and amplifying the impact. As we have argued before, we nearly all have such exposures, although how keenly we recognise them varies greatly.
What does this mean for Sterling? Previously I wrote about this scenario, terming it a 'Rally of Betrayal' and suggesting we could see the pound rise to £1.35-£1.40 against the US dollar.
Although that strength only holds until the fury of the baffled, frustrated, weary electorate is unleashed on the Tory administration. Although as ever the timing of the day of reckoning remains uncertain.
That view was all predicated on Corbyn keeping his poise, holding his fractious party together and gaining from the shambles of the Tory leadership.
The subsequent Labour issues, with both their tolerance for a noisy minority peddling anti-Semitism and indeed their own split over Europe, perhaps makes the great socialist revival a little less likely.
So if all currencies are now pigs, which one would you kiss?
I suspect there will be an element of randomness here, and as we are destined to be forever more European, our politics may well morph into something rather similar: numerous parties, coalitions, and (more) extended periods of no effective government.
And actually seeing how our representatives work, rather cynically, that may not be a bad thing for a while.
At the same time the real threat to Sterling, of a 1970's style socialist government, has we feel been reduced. The Labour Party, oddly strengthened by those defecting MP's, still has a serious core that can fight, even if only intermittently, for some version of sanity and responsible opposition.
But there is much dissatisfaction in these isles aimed predominantly at those that govern us. That is not a good long term development. For all the false dawns of realignment we have lived through, I sense the cracks really are deepening this time.
Yet for now I suspect Sterling will hold its gains and we may well see a period of consolidation around £1.40.
We should not forget either the odd stability and fiscal responsibility (https://www.bbc.co.uk/news/business-47318862) of this Chancellor.
Virtue is unpopular, as it often is, and two faced, as it is prone to be, but the years of if not quite austerity, then at least restraint, are lengthening. The day we might actually stop fresh borrowing, quixotic and brief though that dawn will be, slides gently closer.
The Euro as we know has its own problems. It remains a liability currency in my view.
The Sterling Euro rate of 1.25 would then also seem a reasonable result, if indeed the pound moves up against the dollar.