Investors all remember European Central Bank President Mario
Draghi's speech last August where he said that the ECB would do
anything in its power to protect the euro. Five months later,
credit spreads of peripheral nations ensnared in the debt crisis
over those of safer nations have narrowed, showing at least some
success of Draghi's ultimatum.
However, Draghi's announcement of the Outright Monetary
Transaction (OMT) program had one negative effect for the
Eurozone that could inevitably weigh on the world economy. By
defending the euro, defending individual nations' solvency,
Draghi created a large dilemma for both himself and the Eurozone
as a whole.
The strength of the euro has been somewhat remarkable since
Draghi's ultimatum. The EUR/USD rallied sharply after the
announcement through the end of the year as investors no longer
feared a break-up of the euro. In short, the euro rallied not
because it was fixed but because it would still exist in the
future. The imminent break-up risk of the euro had been removed
and markets re-priced this risk.
The strong euro will eventually cost Europe dearly though. As
PIMCO CEO Mohamed El-Erian wrote in the Financial Times Tuesday,
"with growth already sluggish, the eurozone can ill afford a
stronger currency. Sharp appreciation undermines economic
activity - not only for export powerhouses such as Germany but
also for countries such as Spain where, for the past eight
quarters, the contribution of net exports has been positive."
"Expect the ECB to be pressed hard to join other central banks
in actively seeking to depreciate the currency - by cutting the
policy rate (currently 0.75 per cent) and quantitative easing of
the type pursued by the Bank of England, the Bank of Japan and
the US Federal Reserve." El-Erian also warns that, should the ECB
enter the devaluation game, it would truly mark the beginning of
a global currency war.
Remember, currency wars and export-driven growth is a zero-sum
game. If the Bank of Japan weakens the yen, it weakens relative
to another currency. Therefore, as much as Japanese exports get a
boost from a weaker currency, the other trading partner's
currency strengthens and their exports decline. If countries
compete in a game of devaluation, fiat currencies will all
decline and no currency will devalue all that much relative to
In this game of currency wars, the only solution for investors
is to invest in real assets that hedge away fiat currency cash
flows. Investors could buy inflation linked bonds, gold, or real
estate as real assets that provide could provide real income no
matter what happens to fiat currencies.
(c) 2013 Benzinga.com. Benzinga does not provide investment
advice. All rights reserved.
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