Central Planners Wrong Again

Based on action by central bankers, the euro should be weakening relative to the dollar, yet just the opposite is happening.

The Federal Reserve Board has been raising interest rates and “normalizing” its $4.5 trillion portfolio, while the European Central Bank (ECB) is “carrying out the most aggressive monetary expansion in the world” outside of Japan.

We also have more rapid economic growth, rising inflation expectations and a trade deficit that is at its lowest level in a decade – yet the dollar is the weakest it’s been relative to the euro in three years.

The euro has strengthened because of the trade surplus of China and the Eurozone, according to economist Daniel Lacalle. Writing on the Mises Wire, he added that, “Central banks should know it is difficult to have rising trade profits and weakening currencies.”

Consumers Benefit, Central Bankers Don’t

As we’ve noted in the past, the relative strength of a currency has both advantages and disadvantages.

The strong Euro makes imports cheaper, which benefits consumers. By especially helping to keep the prices of energy and food in check, it creates “a significant wealth effect,” according to Lacalle.

“But a strong euro is bad news for central planners, indebted states and obsolete or low value-added sectors that need the hidden subsidy of devaluation,” Lacalle wrote. “A strong euro destroys the ECB expectations of inflation, the increase in estimated profits of the low productivity sectors and puts in danger the debt reduction of inefficient states, which have been unable to reduce their deficits quickly enough.

“The ECB´s monetary policy, which becomes an assault on the savers and efficient sectors to subsidize the inefficient and indebted, does not work in a globalized world with open economies. And, ironically, that is good for European families, who see their wealth in deposits strengthen and stable disposable income because inflation is low.”

The U.S. can benefit, too. With the dollar weak even as the U.S. economy is growing, Lacalle sees an opportunity for the Fed to “raise rates and strengthen options ahead of a global slowdown without worrying about its currency.”

Just Another Central Bank Failure

The ECB’s failure to weaken the euro, which would lower the cost of European exports for American consumers, echoes the Fed’s failure to boost inflation. As we’ve noted, the Fed has been trying for years to boost the rate of inflation to 2%. The ECB has likewise failed to meet its 2% inflation target, although deflation no longer appears to be an issue.

When the Fed overshoots its target and the goal becomes reducing inflation, the same people who failed for so long to increase inflation will be in charge of reducing inflation. Hold on to your Ford-era WIN (Whip Inflation Now) button.

Will central bankers blame themselves for their current failures? That’s not likely, according to Lacalle.

“Central planners and their batteries of Keynesian analysts are surprised that economies do not work as their Excel spreadsheets assume,” he wrote. “Expected correlations and causations fail. But they do not admit their own mistakes. They do not attribute it to the fact that their correlations and estimates are obsolete and wrong, but that ‘not enough was done’ and ‘it would have been worse’ and their religious faith in interventionism remains untouchable.”

When all goes wrong, Lacalle believes central bankers will do what they always do during a crisis – call for more regulation.

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