The single most important factor in the analysis is that two currencies cannot devalue against each other at the same time. It’s a mathematical impossibility. If one currency is going down against another, then the other must be going up. There’s no other way.
From January 2010 (when Obama launched the currency war) to August 2011 (when the dollar hit an all-time low), the currency wars benefited the U.S. at the expense of Europe, emerging markets and China. This was considered necessary by the participants at the G-20 leaders summit in Pittsburgh in September 2009.
The U.S. was and is the world’s largest economy. If the U.S. could not escape the impact of the 2008 financial panic, no one else would, either. In effect, the world would suffer stronger currencies while the U.S. devalued to jump-start the global recovery.
After August 2011, the dollar was allowed to revalue upward while the rest of the world, especially Europe and China, was allowed to devalue so they could claim some benefit from a weaker currency. This worked in the short run, but the problem was that the U.S. never returned to sustained growth at the prior trend of 3.25% growth per year.
The U.S. endured a long depression from 2007 until today with annual growth of about 2.3%. Europe and China got a boost, but the U.S. never pulled away from the pack.
Since then, it has been a matter of taking turns. The euro is allowed to depreciate to help growth and the banking system as the dollar gets stronger based on a slightly stronger U.S. economy. But no major economy has solved the problem of achieving self-sustaining trend growth.
China has been free-riding the entire time. There have been periods of a soft peg of the yuan to the dollar, but there are intermittent periods of a weaker yuan. China executed shock devaluations in August 2015 and December 2015.
Both times, U.S. stocks fell 11% in a matter of weeks. China has just executed a 10% slow-motion devaluation over the past six months. U.S. stocks have started to sink again.
Now Trump and Mnuchin are saying, “Enough!” The Europeans will have to take their turn with a stronger currency and China will be penalized for their currency manipulation. A weaker dollar is coming.
Whether this will be achieved with cooperation by the Fed or direct intervention by the Treasury remains to be seen, but a weaker dollar is the only way out of the U.S. growth conundrum and debt debacle.
The chart below shows that the euro has settled into a trading range since April after coming down from the $1.25 range in February.
Chart 1:
The euro will break out of that trading range toward the upside ($1.20–1.30) over the next few months. This will be the result of a possible Fed pause in rate hikes as the U.S. economy weakens, continued determination by the ECB to tighten policy and possible intervention by the U.S. Treasury.
Meanwhile, a weaker dollar will give the U.S. another growth spurt after the 2018 tax cuts to help propel Trump’s reelection prospects for 2020.
- Source, Jim Rickards
