Why the Dollar is Relatively Strong, Euro Edition

One of the first emergent signs of what is now called Wokeism was an attack on "ethnocentrism" in the 1990s. That's when the universities started cancelling "dead white men" for being white and men. However, the concept of ethnocentrism isn't entirely bad. A person can cloud their judgement by being excessively focused on the near while ignoring the far. This has been most evident among the dollar bears who are so focused on the failures of the Federal Reserve that they cannot see the greater failures of foreign central banks.

The rise of the U.S. dollar exchange rate this year has made monkeys of all the dollar bears. Cyclically, the U.S. dollar was primed for a decline, yet instead it has broken with four decades of cycle history and moved higher. The U.S. economy is shrinking as a share of the global economy, yet as a reserve currency and unit of account, creation of simulacra dollars (Eurodollars) exceeds that of the base money. Base money growth in the U.S. rises, but demand on that base money rises faster because of overseas credit creation.  Hence demand for the base money rises when expansion of the credit money (Eurodollars) slows or contracts.

I predict that, if the U.S. dollar loses reserve currency status, avoids going the way of Zimbabwe and something like SDRs replace it, the U.S. dollar will eventually appreciate versus the SDR. For the same reason the German deutschmark would appreciate versus a rump euro. Whenever there is a shared resources such as a common currency, he who prints most will drive the value of the currency lower.

Mises.org: ECB’s Long Journey into Currency Collapse Just Got a Lot Shorter

The new instrument, born under the name “transmission protection instrument” (TPI), will be the catalyst to the accelerated full transformation of the ECB into a bloated European “bad bank” fund. This entity enjoys a giant privilege. Its liabilities are in large part the designated money (whether as banknotes or as reserves of banks) enjoying huge protections as such (most importantly legal tender) in all member countries of the European Monetary Union.

In effect, since the EMU crises of 2010-12, the ECB has been the agent which has “communalized” much of the bad state and bank debt of Italy (also Spain, Portugal and Greece). It has done this by issuing euro money liabilities against giant purchases of government paper and long-term lending (called LTROs) into the corresponding weak banking systems (again most of all Italy).

This communalization has created three big problems for the future of the euro:

The euro is weak because it allowed countries such as Greece to issue "deutschmark" bonds in the 2000s. The euro was strong because of Germany, rather than weak because of Greece. Economic policy in Germany looks even worse than that of Greece in 2022, hence the rapid decline in the euro. The breakup scenario for the euro, however, has always been a German exit because the common currency exchange rate trends towards the most profligate borrowers over time. As soon as the European Union passed on kicking Greece out, it guaranteed the most likely breakup scenario is a German exit.

Third: the tolerance of the German public for this transformation of the ECB and its money could snap in a way which means that the Federal Republic pulls out of the union. Germany has been critical in keeping the ECB humpty dumpty together. Partly this critical role depends on public perception (that Germany stands behind the ECB and all its potential losses), albeit there is much wishful thinking here rather than legal fact.

...If, for whatever reason, the Italian spread (Italian government bond yields vs. German) suddenly widens – perhaps because markets distrust the political direction or sense that Italian credit institutions are in a new bleak situation – then the ECB can turn on the taps. Yes, it will sterilize the new lending, that means presumably disposing of German and Dutch paper in the ECB balance sheet to make room for Italian for example, becoming even more of a bad bank.

There are decisive moments in monetary history. The aftermath of July 21 is likely to be one of them as regards the European monetary future. These problems have become a lot worse

The same logic can be applied to an SDR, special drawing rights from the IMF. Whether it is formal or not, a move to a world with no dominant reserve currency is not that different from one with the SDR as the main reserve asset because in both cases, countries will be using currency baskets. The U.S. losing its reserve currency status would look more like a German exit from the euro than not in terms of the domestic economy. A costly adjustment period followed by the U.S. "decoupling" from the global economy as it becomes free to pursue a mercenary America First national economic plan. Placing tariffs on Chinese goods and on Chinese purchases of U.S. assets is fraught with economic costs today because it threatens the reserve currency status of the U.S. dollar. 

In the near-term though, it is the breakup of the euro that is helping lift the U.S. dollar because the (formerly?) dominant Germany economy is being pulled down by green idiocy, Baizuo foreign policy and the deficit spenders in Southern Europe. Declining social mood makes a total breakup increasingly likely. Keeping the euro together will require printing money much faster than in the United States. Investors and businesses that leverage themselves on the assumption of a relatively weak dollar will experience deflationary collapses as happened in 2008, 2011, 2014, 2018, and again in 2022.