The Next Big Move in FX Markets
It’s only a matter of time before the euro suffers a huge fragmentation as German policy makers bring back the deutsche mark. This one move will serve as the cornerstone of transformation for the Eurozone. We have been expecting this transformation in reference to the domestic use of the euro for some time now.
The monetary imbalance challenges in the Eurozone are a micro version of the international macro imbalances. The economic and financial pressure which is building between trade surplus nations and trade deficit nations, on both levels, will need to be dealt with sooner rather than later.
Maintaining the existing composition of the euro is putting huge financial strain on the other European Union members. Banks in most other EU nations, especially Italy, are insolvent and are on the verge of collapse. A strong euro only enhances and complicates the situation.
One core aspect of the POM thesis is that each EU nation will return to using its own domestic currency while continuing to use the euro to balance trade with one another. The benefit of such a move is that each nations debts could be re-denominated in domestic currency and marked down without effecting the overall value of the euro.
Some EU nations could benefit from a lower euro, but there are other moving pieces which need to be considered, such as the euro position within the broader international monetary system and SDR basket.
Considering the Germany situation, the removal of Germany from the euro would allow the deutsche mark to appreciate. The initial moves in the FX markets would be huge as central banks and investors dumped the depreciating euro and capital flowed into the appreciating deutsche mark.
Corporate and consumer interests in Germany would benefit from these changes as the deutsche mark appreciated to 30% to 40% over the euro. This would make euro denominated debt easy to clear with a stronger deutsche mark. The weakening euro would make it more probable for other EU nations to clear debt (whether re-denominated or not) with their own domestic currencies, as each follows suite with a return to national currencies.
German exporters would have to deal with increased export prices, but would also benefit from cheaper importing costs. But the intent overall is to correct the imbalances, and the appreciating duetsche mark would do a lot to reduce Germany’s trade surplus.
The same methodology will happen internationally as the Chinese renminbi will also appreciate and contribute to a reduction of that nations trade surplus. This will also facilitate the move to a consumer based domestic economy which is the ultimate objective of monetary policy makers in Beijing.
In fact, the German trade surplus is now larger than China’s, and though a strengthening euro would serve the same purpose for reducing the German trade surplus, it would do so by increasing the trade deficit problems for other EU members. This is not a workable solution and a different path forward will need to be taken.
The German election on September 24th will be telling about how soon such a move can take place. There is a growing political appetite in Germany for such a dramatic move, much like the Swiss did a few years ago. Though it has been talked about, it would likely catch investors by surprise, much like the Swiss move did.
The German consumer could pay off euro issued debt which they have accumulated over the last few decades, and would find their purchasing power increasing. This would be an easy political sell, but it is hard to imagine such a huge move taking place before the election in a few weeks.
Angela Merkel’s party is strangely doing well in the polls in the lead up to the election. The German proportional system could even provide a convenient political partnership in the event she came up short, which would also ensure she remained as Chancellor. The slow and incremental German shift towards the East, and a deeper alliance with Russia and China, will also contribute to Merkel’s political sustainability.
Based on the current German political environment, there is no immediate demand to make such a move, but it should be considered that it could happen in the months after the election. The international imbalances between America and China are making it more important than ever that some form of EU transition is made to correct the imbalances between Germany and other EU members.
A deutsche mark move would have to happen before any substantial dollar depreciation, as both happening simultaneously would provide too much of a financial one-two punch on the FX markets. Based on the initial EU Central Bank purchase of RMB denominated bonds, there could be a forward move with the duetsche mark and euro which would also benefit the Chinese currency, and contribute to its appreciation, which in turn would act as a depreciating mechanism on the USD.
Watch the weeks after the German election. – JC
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JC Collins can be contacted at firstname.lastname@example.org