With the election, sequestration showdown and other pressing domestic news, we’ve hardly had time to think about Europe. Yet the continent is as troubled as ever and is crying out for attention again.
Keep in mind that, in this era of a global economy, our fates are intertwined. Europe and America are heavy trading partners and our multinational businesses are located throughout each other’s continent. Our banks own European bonds. So when Europe is in trouble, so is the U.S.
Well, Europe is in trouble. We’d say “in trouble again,” but it’s never really gotten out of trouble; at least not since Greece triggered the sovereign debt crisis. The popular British game show, “The Weakest Link,” could serve as a metaphor for the whole continent, except that what’s happening in Europe is not nearly as entertaining.
GDP Dropping
The euro zone reported this week that its economy shrank for a fourth consecutive quarter, leading to a 0.5% drop in gross domestic product (GDP) for the year. It was the first time the zone’s economy shrank for four consecutive quarters since 1995. Even stalwart Germany saw its economy shrink by 0.6%; unlike most of Europe, Germany has not been in a recession, which is defined as two consecutive quarters of negative growth.
According to Reuters, the euro zone “slipped deeper than expected” into recession, shrinking “at the end of a wretched year for the region.”
And it looks like the wretchedness will continue for the foreseeable future.
The War for Weakness
To push out of the recession, many in Europe would like a weaker Euro, because a weaker currency provides competitive advantages to exporters. The euro is up about 13% against the dollar since last summer, hurting Europe’s efforts at economic recovery, because its goods become more expensive for other countries to purchase.
However, the war for weakness is global. The U.S. has been weakening the dollar for more than a decade, and China and other countries likewise have been following suit. Now Japan is seeking to weaken its currency.
With the finance ministers of the G20 countries meeting today and tomorrow in Moscow, the currency wars are bound to be a hot topic.
Keep in mind that currency manipulation is unfair only if someone else is doing it. It would be difficult to identify a G20 country that has not embraced the strength-through-weakness protectionism of currency manipulation.
Quantitative easing, through the purchase of bonds and printing of money, is the preferred method for weakening currency these days. Japan is in its 11th round of quantitative easing and its economy is still a mess. The United States, of course, is in its third round of quantitative easing – and the current round could continue for years, as it has no end date.
When everyone’s currency is weak, of course, there is no competitive advantage, as currency values are all relative. So what is the endgame of the currency war?
“(T)hat the G-20 did not accuse Japan of engaging in what everyone clearly knows is currency war, does not mean that everyone else is not doing this,” Zerohedge wrote. “To the contrary: they are, and the lack of a stern rebuke of Japan simply means the currency wars will now intensify, devolving into the same protectionism and trade wars as the first Great Depression was so familiar with, which to borrow a parallel from history again, will end with the kind of war that ultimately ended the first Great Depression.”
It’s a bit severe to predict another Great Depression and World War III, but worldwide currency manipulation is bound to have some nasty side effects.
Higher inflation is one usual side effect. Imported goods become more expensive when a currency weakens, and when the price of imported goods increases, the price of domestic goods follows suit, since domestic companies can raise prices and remain competitive.
When prices increase, consumers buy less, save less or carry more debt. Less purchasing by consumers reduces sales, which can lead to a recession.
With Europe again in a recession and the U.S. economy barely growing, it’s clear that the quantitative easing and currency weakening that has been taking place in recent years isn’t helping. It will continue anyway. May the weakest currency win.