I entered the FX market on June 1st 2012. It was the height of the European sovereign debt crisis, Greece could not take bailout funds because it could not form a government. The Euro was in free fall, plunging on any bad news whatsoever, and failing to hold gains from news driven rallies. On June 17th, when the pro bailout coalition eked out a narrow victory in Greek elections, the Euro popped nearly 200 pips, but then plummeted within hours, giving up all its gains and then some. Its hard to imagine a more bearish market.
This bearish tone was underscored by the glee of many right wing fund managers and speculators which let their emotions and predilections cloud there judgment. A bet against the Euro was bet against socialism. The failure of the Euro was only further proof to these ideologues that anything short of free-market capitalism in its purest form was bound to fail. Or better put, in their Ayn Rand-Ron Paul echo chamber, the EU and Euro had to fail.
To the Euro bears' credit, European fundamentals were looking pretty bleak last May. Yields on Italian and Spanish bonds were over seven percent. Most of the periphery countries were in recession, and the core nations of Germany, France, and Great Britain were hoping to avoid negative GDP growth. In other words, 0 percent growth was looking like a surprise to the upside. Such bleak prospects certainly deterred investment, and warranted a weakening in the Euro, but it did not spell irrevocable doom for the common currency. Europe remains a highly developed economy, with functioning democracies, an educated population, and competent central bankers. Europe is still an economic super-power, and therefore, unlike many emerging market economies, it has the unique luxury of being able to shape its own economic destiny.
And the policies to shape that destiny were obvious to me and many other analysts back in June of last year. The ECB must purchase bonds from the peripheral countries to reduce the 'sovereign premia' which were causing the debt crisis. Meanwhile, the IMF and European Council would enforce reforms and credible deficit and debt reduction plans on the countries in trouble like Greece, Spain, Portugal, and Ireland. There would be no internal devaluation. Such a policy would take decades and would kill the patient well before the cure. Instead, the asset purchases by the ECB would cause inflation in the core to be higher than in the problem countries. This would increase the competitiveness of these countries without forcing nominal wages and prices to fall. So was it any surprise, on July 26th, when Mario Draghi, the head of powerful central bank which set monetary policy for one of the major economic engines of the world, said this in a speech?
Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.
Suddenly, governments, which the vast majority of the Euro bears hated, were ready to act. So no, an economic super power was not going to stand idly by and go quietly into the night. Is it really that surprising that a goverment with the wherewithal to save itself did so?
Today, we see a similar currency devaluation with Japanese Yen. Like Europe, Japan faces enormous economic challenges However, like Europe, Japan is an economic superpower, with incredible wealth and prosperity relative to most nations of the world. The crucial difference is that the Yen depreciation is part of the government's recovery plan. A bet against the Yen is not so much a bet that Japan will fail as a state, rather, that the BOJ and the new LDP government with follow through on their stated programs. To be sure, poor fundamentals will certainly weigh on the Yen in the short term. But in contrast to the Euro, these poor fundamentals will be on top of the main drivers of Yen weakness, central bank and government action. Eventually, Yen depreciation will be a major factor in Japan's return to prosperity as Japanese products become more competitive abroad.
Europe and Japan have a long way to go to return to economic prosperity, but it is foolhardy and arrogant to believe that the leaders of such economic powerhouses would just sit back and wait for the phone to ring.
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