Originally written in early July 2022, some edits in October 2022. This has been highly inspired from Arthur Hayes very insightful writings that you can find here.
This is my essay to try and make sense of the ongoing events in the reserve currencies markets. It seems like this is the current drive of financial markets and economies. I’m specifically interested in the fate of the Euro, where my close ones and I live. In my perspective, it doesn’t bode well for the old continent’s currency.
I’ll first look at the causes leading to the current situation, and the consequences I see for the coming years.
1 - Money printing from the US and EU with ever lowering rates, accelerated with COVID
Since 2008, cheap money from ever lower interest rates has been the norm. Governments and companies could finance themselves at decreasing cost, and their debt level never stopped increasing. This accelerated a lot with Covid (see 2020 below) when money was needed to help the populations and maintain the system while unproductive.
2 - Inflation ramping up (mainly financial markets first)
When too much money is created compared to economic output, inflation starts increasing. It started immediately after Covid with financial markets (not reflected in official consumer inflation numbers) and moved on to food and energy more recently. The accommodating Covid money policy from states laid the right environment for consumer inflation to rise.
3 - Ukraine war: tightening of energy, commodities, and food supply in Europe and in global markets
Blend in a war in Ukraine with gas cuts from Russia and stress on food supplies, and you have the perfect cocktail for booming inflation. This is what we saw this summer with double digit consumer price increases in many countries (US, UK, Germany, …)
We can note that cutting nuclear reactors and increasing its energy dependence to Russia was a big mistake on Germany’s end.
Central banks and governments find themselves in a tricky situation: they need to raise interest rates so that inflation doesn’t go out of control, but this makes it more difficult for governments to finance themselves and keep helping the populations.
1 - Central banks need to hike rates to fight inflation.
2 - US can resist a stronger hike than other economic areas (read EU), because most other countries won’t be able to finance themselves anymore if hike too strong.
The gap in the hike race has already started. The FED is the leader, while the BOJ already capitulated and is back to money printing. Edit October 2022: BOE capitulated as well after the government passed a big tax cut, reducing their future revenue.
In EU’s case, Germany, supposedly the strongest country economically, is already in trouble with a trade surplus heading towards negative territory. Winter is coming, and the energy situation is not improving. As Germany’s manufacturing plants are at a stop, this is not when the ECB are likely to become more aggressive in their rate hikes.