Martin Spring: On Target
Comment of the Day

May 06 2014

Commentary by David Fuller

Martin Spring: On Target

My thanks to the author for his ever-interesting monthly letter on global strategy.   

Here is a section on the euro which may raise a few eyebrows:

Conservative policies aren’t just good intentions

Factors that have kept the euro strengthening this year include attractive valuations of European shares relative to US equities, the safety of Eurozone markets relative to the volatile ones of the emerging economies, declining fears of a debt crisis in European banks, and currency risk in Japan.

Perhaps more importantly, markets like the visible proof of conservative financial policies – the European Central Bank’s balance sheet is shrinking as banks repay loans they took out at the high of the Eurozone crisis, while the US Federal Reserve’s continues to inflate.

The euro has regained its appeal as a currency of choice for central banks, with its share of foreign exchange reserves rising to 24.5 per cent, according to latest figures, while the dollar’s share falling to 61.7 per cent. And that’s excluding China, which does not reveal the currency breakdown of its reserves, but is also believed to be accumulating euros.

Longer-term, it seems highly probable that the world’s strongest major currency will be the yuan, as China’s economic and financial power strengthens relative to its competitors’, particularly the US.

I see little to choose between the euro and the dollar, except that structural factors favour the euro – assuming, as I do, that the Eurozone is able to hold together, because for all its member-nations the alternative would be worse.

Europe has no central Treasury able to enforce fiscal policies. Its central bank is restricted in what it can do, and cannot act without the support of a dozen governments. All major decisions require protracted negotiations among many sovereign states with often-conflicting interests or attitudes.

Because political and financial power is more centralized in the US than in Europe, it’s easier for the Americans to resort to extreme, and longer-term potentially more dangerous, money-creation and trade-protection policies.

It’s easier for them to manipulate their currency as a weapon to advance their national interests than it is for the Europeans to do so. Counter-intuitively, that suggests the euro is likely to be the somewhat-stronger currency of the two, over the longer-term.

David Fuller's view

Here is Martin Spring's Letter.

Martin Spring opens this section with some interesting points regarding the euro.  Needless to say, they would have been highly controversial if written a few years ago.  In fact, if we recall forecasts and predictions on the euro from various economists, financial pundits and strategists – many of them were expecting the euro to either collapse entirely, or for at least some countries in the single currency to have dropped out, or for a break up resulting in separate northern and southern European versions of the euro.

The fact that none of this has happened is testimony to political resolve and a fear among EU members of the euro zone that they would be even worse off without the single currency.  I also remain convinced that the brilliant and politically astute ECB governor, Mario Draghi, was instrumental in holding the euro together, throughout by far the most difficult economic crisis for the single currency to date.  The euro will remain an important currency, I maintain, for so long as its constituent states have the political will to hold it together while aspiring to principles of sound economic governance.  This latter point remains the longer-term challenge.  

I was interested in Martin Spring’s comment: “Longer-term, it seems highly probable that the world’s strongest major currency will be the yuan.”  If so, that could be reassuring as it would almost certainly mean that China’s economy remained both successful and somewhat more democratic.  However, authoritarian regimes have a long history of driving away their entrepreneurial talent, due to the efforts of political kleptocrats to control their activities and exploit their abilities. 

Will the euro be somewhat stronger than the dollar over the longer term, as Martin Spring also suggests?  That would also be reassuring as it could only occur if Europe’s productivity and GDP growth continued to improve.  This would obviously be good for the majority of Europeans and also the global economy.  Europe certainly has the talent and potential to achieve this but the EU’s heavy handed bureaucracy remains an impediment, in my opinion.  Meanwhile, this 10-year chart of EUR/USD continues to support Martin Spring’s point in the short to medium term because the euro continues to range higher above its rising 200-day MA.  

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