While the markets were up for the week, we saw the return of Europe in the crosshairs of the rating agencies as many countries received downgrades after the markets closed Friday. Of equally high concern is the rapidly deteriorating situation with Iran. It appears that something bad is brewing there. Consider that a second aircraft carrier has moved into the gulf region, U.S. generals are visiting Israel, sanctioning of the Iranian central bank has impacted the Iranian currency, and Iranian nuclear scientists are being assassinated.
The one thing to keep in mind in regard to global markets is that currencies have a lot to do with all of the other markets and their performance. If the Euro weakens (and it has been dropping), that means the US dollar rises; and if the US dollar rises, then stocks sink. The easy way to ensure that the dollar stays weak is to print more dollars. My suspicion is that if the Euro starts to win the weak currency race through their own economic funk, then the Fed will cut that race off at the knees and print more money to push the US currency lower. More on the currency war below.
I’d like to start this topic with a short review of the formula for Gross Domestic Product (GDP). GDP is the total value of all goods and services produced in a country. GDP = C + I + G + (X-M). The C is for consumption, the I is for investments, the G is for government spending, the X is for exports, and the M is for imports. X-M is the formula for net exports.
When an economic slowdown grips a country, or a recession sets in, the indicator many point to is a slowdown in GDP. Keep in mind that economic contractions pull down consumption (C) usually as a result of unemployment or debt overhangs. This leads to investment (I) slowing as businesses hunker-down for lower demand. Government spending (G) can be increased to try to offset the slowdown in C and I. This government expansion is in fact what Keynesian economists push endlessly. The problem is that countries like ours are supposed to run on taxes, and possibly borrowing, to pay the bills. For government to expand spending, they must either tax more or borrow more. In an economic slowdown, politicians are hesitant to raise taxes to support more government spending. In our case, we have borrowed endlessly. What you will notice is that I have dismissed all the components of the GDP formula except the (X-M).
The sneakiest way for a government to try and boost GDP is by increasing exports through the currency markets. The easiest way to increase exports is to debase the exporting nation’s currency. Since the currency debasement trick is not a secret, and just about every Western nation is looking to boost exports, we are in a global currency war as a result of the current global economic funk. What does history show to be the unintended consequences of currency wars? High unemployment, low growth, weak banking sectors, lousy public finances, and often times, boots on the ground wars. I would imagine that the list of historical unintended consequences of currency wars sounds familiar.
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John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.