Weakness of Euro, Pound, Yen, Loonie Are Ominous Signs

Commentary, Public Finance & Fiscal Federalism, Taxation, Ian Madsen

Too much could be read into the recent sagging value of the Euro, British pound, Japan’s yen and Canada’s loonie against America’s dollar.  Relative interest rates, trade deficits, and government deficits and trends have major influences.  In the longer term, all those factors plus additional other aspects of relative economic strengths and attractiveness between countries will come into play.

The world’s main reserve currency, the U.S. dollar, had been devaluing for over sixty years, as it suffered from huge fiscal federal deficits. The resulting inflation destroyed Americans’ purchasing power by about eighty percent against the stalwart Swiss franc. Yet, the United States has an unusual advantage over other nations:  its very broad, deep and diverse debt and equity (stock) markets.

EU and other nations’ profligate borrowing weakens their currencies, but inflows of foreign money to buy U.S. bonds and stocks causes the U.S. dollar to rise in relative value versus other currencies.  While interest paid on DC’s rising debt is an outflow, it is dwarfed by the inflows.  In the 1980’s, this made the U.S. dollar soar, hurting U.S. exports, forcing brutal industry cost cutting, especially in manufacturing.

The U.S. has other advantages:  a large indigenous financial industry; including venture capital and private equity, which are relatively undeveloped elsewhere.  Also, it enjoys the world’s largest, most diverse, innovative and competitive economy, with services of every type to facilitate ventures.

Debt aside, the U.S. is still attractive for investment, and not just in the more flashy tech- or medical-related sectors. Its population is still growing (though not as fast as Canada and Australia), while the EU and Japan are relatively stalled.  It is a challenge to attract domestic and foreign investment.  Unlike the U.S, Canada, the U.K., Japan and the EU do relatively poorly, here. Some ideas or rules help here.

‘First do no harm’:  Constraints and penalties that slow existing commerce and deter new activity are few in the U.S.  ‘Get the basics right’:  Law and order, sound civil justice, high quality infrastructure and other basic services prevail. ‘Do not make things complex or difficult.:  EU ambivalence to business and a highly untenable energy policy boost investor risk, lower returns and increase the reluctance to invest.

The result:  low capital inflows into the Euro zone.  Ever-rising debt inflows do not, unlike in the U.S., boost their currencies, nor do their policies entice capital into ventures that authorities later stymie or penalize. Similar attitudes and policies harm Canada, the U.K. and Japan.  The U.S. offers comparative ease of doing business, reducing the time and cost to get projects launched and successful (vital to growth, and prosperity).  Governments that forget the rules noted above cause dismal stagnation.

Switzerland’s currency alone has steadily risen.  Why? The Swiss state has low taxes, a light touch, and the Swiss federation’s  ‘cantons’ compete to have the lowest taxes and favourable economic environment.  Canada, the U.K., Japan and the EU could emulate this.

Thus far, they have not, and the results show in the currencies.

 

Ian Madsen is the Senior Policy Analyst at the Frontier Centre for Public Policy