The Most Decisively Damaging Action
By John R. Taylor, Jr.
We never thought Winston Churchill would be cast as a heroic figure in Germany, but Angela Merkel, Wolfgang Schäuble, and the rest of the political leadership seem to be doing just that by following the economic script he laid out for the United Kingdom in 1925. Over the years, it didn’t work out too well. John Kenneth Galbraith in his 1975 book Money: From Whence it Came and Where It Went, wrote that Churchill’s decision in 1925 as Chancellor of the Exchequer to return to the gold standard was “perhaps the most decisively damaging action involving money in modern time.” The way the European economic and political situation is developing, the odds are increasing that the establishment of the euro will at least rank on a par with Churchill’s misstep. This ‘goldmimicking’ standard is forcing one size to fit all in a way that is more binding than gold itself. As Merkel and Germans in general are regarded as the taskmasters enforcing the euro, we fear that the continent-wide social and political outcomes could mimic those of the inter-war period with disastrous implications for the dreams of every European. When Britain went back on the gold standard at the old pre-World War I level, it accepted a deflationary impact on wages and prices that would increase the social and political strains within the country. It was felt at the time that a currency tethered to gold would make the playing field a level one and that the British Empire should be the global leader on this issue. Clearly, Churchill’s reason for this move was not entirely economic, but was political as well: the British were to lead the world as before. Inside the country the result was immediately negative as unemployment grew and growth shrank. The coal mining sector was the most harmed by the forced ‘internal devaluation’ that this move brought about. Rather than accept a cut in wages, the miners went on strike, precipitating a nationwide walkout. It took more than a year for this tumult to run its course, with labor being the loser and the ‘rule of law’ the victor. Britain’s example in reestablishing gold as the centerpiece of the post-war system impacted the whole European economic situation and eventually aggravated the downturn in the early 1930’s. The social disruption initiated by Churchill’s move and the related economic collapse of the 1930’s was an important factor in the slide toward war.
Under the euro ‘gold-mimicking’ regime, Germany has been on both sides. When the original fixed valuations were established, the Deutschemark was valued too dearly as a result of the unification a few years before, which lead to a process of ‘internal devaluation,’ which ran for many years, ending in 2005. Gerhard Schröder, German Chancellor during the first years of the euro, oversaw the tough times necessary to bring German wages and prices down to competitive levels with the rest of the Eurozone, and watched his party, the SPD, lose political support as he won the economic war. Germany’s long-term trend had always been toward higher productivity, and its highly structured social system, allowed it to bring its costs into alignment with less pain than would be suffered by other countries without this history. After a few years of equality within the euro, the shoe is now on the other foot, and the others are being forced to devalue internally, some more dramatically, some less. Over time, this will be a social hell. At least under the gold standard, escape was possible. Under the euro it is not.
Germany Against the Masses
By Jonathan Clark
German politicians are adamant they won’t bail out the fiscally irresponsible peripheral European countries, but are also committed to keeping the euro together. This is becoming increasingly difficult, with Southern European euro members voicing their displeasure that austerity has led to rising rates of unemployment without the promised cut in debt-to-GDP ratios. Sovereign borrowing rates have been falling in the higher interest rate countries, so there are no signs of fiscal strain, but the critical problems in the region continue to involve the lack of both economic growth and competitiveness. Outside of Germany, the solution to the latter problem has been austerity and reducing real wages, ‘internal devaluation’. Patience outside of Germany is starting to fade and, increasingly, countries like Spain and Greece are blaming Germany for their economic troubles – a trend likely to spread. Already Spain, Portugal and France are talking about stimulating their economies. As the theories of Reinhart and Rogoff regarding the negative impact of high debt-to-GDP have been compromised, this is beginning to lose support. But within Germany, the party line is no bailouts and governments must resolve their own banking problems, all while sticking to their austerity programs and debt targets. There are calls for Germany to stimulate its economy now that it is flagging. Wage hikes and rising prices could also help the competitiveness problems in the Eurozone, but Germans loathe inflation. If recession continues, Eurozone banks will have problems funding themselves and the ECB might refuse their collateral. Under the new, German-backed, formula the equity and bond holders, as well as depositors, must suffer. For now, solving the growth problem has been up to the ECB and a rate cut appears likely on May 2, and possibly a scheme to increase lending to small and mid-sized companies, and either step should undermine the single currency. We do not expect a rate cut to have much impact, but a weaker euro will.
EUR/USD should continue its downtrend for another few weeks before a medium-term low is reached. It has already lost approximately 5% since its peak at the start of February, with the Hungarian forint even weaker as it has been in a downtrend since October. The cycles argue the single currency should trend lower into the week of May 6, when a medium-term low is due, reaching 1.2840 at a minimum and possibly our target of the 1.2550 area. The euro should then recover for several weeks before resuming its downtrend into July and possibly August. Our further objective is the 1.2100 area. Sell euros on strength and the next few days could provide an opportunity. It can see strength into the end of the week. The 1.3110 area should be a good place. Only a break of 1.3215 turns the outlook positive into mid-May, but this is unlikely.
By John R. Taylor, Jr.
We never thought Winston Churchill would be cast as a heroic figure in Germany, but Angela Merkel, Wolfgang Schäuble, and the rest of the political leadership seem to be doing just that by following the economic script he laid out for the United Kingdom in 1925. Over the years, it didn’t work out too well. John Kenneth Galbraith in his 1975 book Money: From Whence it Came and Where It Went, wrote that Churchill’s decision in 1925 as Chancellor of the Exchequer to return to the gold standard was “perhaps the most decisively damaging action involving money in modern time.” The way the European economic and political situation is developing, the odds are increasing that the establishment of the euro will at least rank on a par with Churchill’s misstep. This ‘goldmimicking’ standard is forcing one size to fit all in a way that is more binding than gold itself. As Merkel and Germans in general are regarded as the taskmasters enforcing the euro, we fear that the continent-wide social and political outcomes could mimic those of the inter-war period with disastrous implications for the dreams of every European. When Britain went back on the gold standard at the old pre-World War I level, it accepted a deflationary impact on wages and prices that would increase the social and political strains within the country. It was felt at the time that a currency tethered to gold would make the playing field a level one and that the British Empire should be the global leader on this issue. Clearly, Churchill’s reason for this move was not entirely economic, but was political as well: the British were to lead the world as before. Inside the country the result was immediately negative as unemployment grew and growth shrank. The coal mining sector was the most harmed by the forced ‘internal devaluation’ that this move brought about. Rather than accept a cut in wages, the miners went on strike, precipitating a nationwide walkout. It took more than a year for this tumult to run its course, with labor being the loser and the ‘rule of law’ the victor. Britain’s example in reestablishing gold as the centerpiece of the post-war system impacted the whole European economic situation and eventually aggravated the downturn in the early 1930’s. The social disruption initiated by Churchill’s move and the related economic collapse of the 1930’s was an important factor in the slide toward war.
Under the euro ‘gold-mimicking’ regime, Germany has been on both sides. When the original fixed valuations were established, the Deutschemark was valued too dearly as a result of the unification a few years before, which lead to a process of ‘internal devaluation,’ which ran for many years, ending in 2005. Gerhard Schröder, German Chancellor during the first years of the euro, oversaw the tough times necessary to bring German wages and prices down to competitive levels with the rest of the Eurozone, and watched his party, the SPD, lose political support as he won the economic war. Germany’s long-term trend had always been toward higher productivity, and its highly structured social system, allowed it to bring its costs into alignment with less pain than would be suffered by other countries without this history. After a few years of equality within the euro, the shoe is now on the other foot, and the others are being forced to devalue internally, some more dramatically, some less. Over time, this will be a social hell. At least under the gold standard, escape was possible. Under the euro it is not.
Germany Against the Masses
By Jonathan Clark
German politicians are adamant they won’t bail out the fiscally irresponsible peripheral European countries, but are also committed to keeping the euro together. This is becoming increasingly difficult, with Southern European euro members voicing their displeasure that austerity has led to rising rates of unemployment without the promised cut in debt-to-GDP ratios. Sovereign borrowing rates have been falling in the higher interest rate countries, so there are no signs of fiscal strain, but the critical problems in the region continue to involve the lack of both economic growth and competitiveness. Outside of Germany, the solution to the latter problem has been austerity and reducing real wages, ‘internal devaluation’. Patience outside of Germany is starting to fade and, increasingly, countries like Spain and Greece are blaming Germany for their economic troubles – a trend likely to spread. Already Spain, Portugal and France are talking about stimulating their economies. As the theories of Reinhart and Rogoff regarding the negative impact of high debt-to-GDP have been compromised, this is beginning to lose support. But within Germany, the party line is no bailouts and governments must resolve their own banking problems, all while sticking to their austerity programs and debt targets. There are calls for Germany to stimulate its economy now that it is flagging. Wage hikes and rising prices could also help the competitiveness problems in the Eurozone, but Germans loathe inflation. If recession continues, Eurozone banks will have problems funding themselves and the ECB might refuse their collateral. Under the new, German-backed, formula the equity and bond holders, as well as depositors, must suffer. For now, solving the growth problem has been up to the ECB and a rate cut appears likely on May 2, and possibly a scheme to increase lending to small and mid-sized companies, and either step should undermine the single currency. We do not expect a rate cut to have much impact, but a weaker euro will.
EUR/USD should continue its downtrend for another few weeks before a medium-term low is reached. It has already lost approximately 5% since its peak at the start of February, with the Hungarian forint even weaker as it has been in a downtrend since October. The cycles argue the single currency should trend lower into the week of May 6, when a medium-term low is due, reaching 1.2840 at a minimum and possibly our target of the 1.2550 area. The euro should then recover for several weeks before resuming its downtrend into July and possibly August. Our further objective is the 1.2100 area. Sell euros on strength and the next few days could provide an opportunity. It can see strength into the end of the week. The 1.3110 area should be a good place. Only a break of 1.3215 turns the outlook positive into mid-May, but this is unlikely.
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