Expect a Crash in the EUR to USD
Dark clouds are forming above Europe’s economy, promising stormy days ahead for the euro to dollar exchange rate. The EUR to USD held up surprisingly well during last year’s Greek fiasco, but there are now too many factors weighing on the currency union. (Source: “Europe’s economy deeply exposed to growing global gloom,” South China Morning Post, January 17, 2016.)
For one thing, the troubles of the Middle East usually spill over into Europe. A civil war in Syria drove millions of refugees to the West, sparking a tense political debate in eurozone nations. The fate of refugees has become the predominant issue of the day, completely eclipsing questions about the economy and financial stability.
Much of these happenings occurred over a backdrop of falling oil prices, leading to a situation we haven’t seen in years. Brent oil prices, the benchmark of European crude prices, is actually below West Texas Intermediate (WTI) prices, the benchmark for North American prices.
The last time that happened was before the shale boom in the United States. Investors are pricing in Iran’s return to global markets as a negative because the industry already has an excess of oil; Iranian deliveries will just deepen the price slump.
And that’s not even the half of it. There’s one more factor that is weighing heaviest on the EUR to USD pairing.
The Euro to Dollar Comes Tumbling Down
Of the myriad concerns for euro optimists, none is more dangerous than the monetary stimulus from the European Central Bank (ECB). To most people, monetary economics is like a 1,000-year-old Greek text; they don’t understand it nor do they care to.
Luckily, I happen to have an odd fascination with that arcane subject, so let me shed some light on why the ECB’s actions are harmful to the euro. It’s not anything sinister; there’s no devious plan by a group of elitist economists. However, there is certain logic to what’s going on. Let me explain.
The Federal Reserve lowered interest rates to near rock-bottom levels after the 2008 financial crisis. It also printed a bunch of cash and used it to buy up assets that posed a threat to the financial stability of the U.S. Europe was not as proactive.
Lowering interest rates is a strategy that countries often use to devalue their own currency. For export firms, the reduced rates help them borrow at barely any cost, while also making prices more attractive relative to other countries.
The U.S. dollar got weaker from Fed intervention and then it grew stronger in tandem with its economy. Now Europe is trying to mimic that strategy, which means the ECB wants the euro to depreciate against the dollar!
Don’t believe me? The European Central Bank started a full-blown stimulus program 10 months ago. It is currently buying 60 billion euros worth of bonds a month, which a majority of economists expect to be increased later this year. (Source: “Draghi Efforts Thwarted by Oil as Economists See More Easing,” Bloomberg, January 17, 2016.)
That is step-for-step exactly what the Fed did to devalue the U.S. dollar.
ECB Stimulus Could Spark a Run on Euros
But there’s a big difference between what the Fed did then and what the ECB is doing now and that’s the state of China’s economy.
At the time the Fed was printing its big bundles of cash, global demand was kept afloat by China’s mega-powered economy. However, a lot has happened since then. (Source: “Sell everything ahead of stock market crash, say RBS economists,” The Guardian, January 12, 2016.)
Growth is slowing in China, falling from double-digit growth to something nearer to seven percent. That may still sound amazing to many of us in North America, but it’s far below the kind of expansion China has enjoyed over the last few decades.
A Chinese economic slowdown is very bad news for Europe’s attempt at recovery. It means that the ECB’s stimulus could help drive down the EUR to USD, but could also fail to help improve the economy. So even after sabotaging its own currency, the eurozone might not be able to recover its previous glory.
In case you haven’t picked up on my (oh-so-subtle) signals, I am planning on staying as far from the euro as possible.