As the great monetarist economist Milton Friedman once noted, changing the exchange rate is a simple way to change all the prices in an economy in one fell swoop.
This has not been healthy for either region. The eurozone’s trade surplus would suggest it needs a higher not lower exchange rate. More worryingly both areas have had negligible local growth rates as consumers and businesses feel reluctant to spend in response to sclerotic labour markets, inhibited entrepreneurship and prohibitive regulation and taxation.
Rather than apply much-needed supply-side reforms, both the eurozone and Japan have relied on a weak exchange rate against a rampant US dollar as an easy prop – a solution that may help a little in the shorter term but hurts longer-term prospects.
And it is a reappraising of these longer-term prospects that ultimately hurts the stockmarket. A stronger US dollar harms emerging markets and prevents necessary reforms in a number of key developed markets. This is neither good for the world nor its financial markets.
So can the US dollar easily, magically fall? The final missing piece of the story is its impact on the US economy.
A higher US dollar is crimping US corporate earnings growth – another source of the recent volatility in financial markets. A change to the current, broadly consensus view that everything is wonderful in the US economy is just the sort of economic occurrence that can send the US dollar southwards… to the imbalance-reducing benefit of all.
Chris Bailey is a European strategist at Raymond James
