Does Europe really need a weak dollar?

The last
thing that highly indebted Italy and Spain with their weak banking systems need
is a strong Euro. Yet that is exactly what they are getting courtesy of a
rapidly weakening US dollar. This has to heighten the probability that within a
year or so we will have another, more vicious round of the Eurozone debt

Eurozone GDP numbers underline the economic trouble in which Italy and Spain —
the Eurozone’s third and fourth largest economies, respectively — find
themselves. Whereas in the second quarter of 2020 US output declined by 9.5
percent, Italy and Spain experienced quarterly declines of 12 percent and
18.5 percent, respectively. That in turn is putting considerable pressure on
those countries’ already troubled banking systems. It is also putting
those countries’ public-debt-to-GDP ratios on a path to reach 160 percent in
Italy and 120 percent in Spain by year’s end.

People wearing protective masks walk through San Miguel market, amid the coronavirus disease (COVID-19) outbreak, in Madrid, Spain, July 31, 2020. REUTERS/Javier Barbancho

Italy and Spain’s prospects for growing their way out of their debt and banking
sector problems are both a high dependence on
their tourist sectors — which are being hit particularly hard by the global
pandemic — and their limited space for fiscal stimulus. This latter
consideration explains why, the Italian and Spanish fiscal response to the
pandemic has been but a fraction of that in the German and US responses, despite
much deeper pandemic-related economic plunges than in Germany and the
United States.

It also does
not help their economic recovery prospects that Italy and Spain are stuck in a
Euro straitjacket. That precludes them from being able to use an independent
interest rate or exchange rate policy to jump-start their troubled economies.
It also makes it difficult for these countries to address their incipient
deflation problem, which now threatens to compound their debt problems.

Now adding
to Italy and Spain’s problems is the market’s apparent growing loss of
confidence in the US dollar. The market’s concerns seem to include the massive
increase in the US money supply, the apparent resurgence of the US pandemic,
and political uncertainty ahead of the November election. The net result is
that over the past six months, the US has depreciated by almost 10 percent
against the Euro. That dollar depreciation is bound to have worsened Italy and
Spain’s already weak international competitive position and to have put further
deflationary pressure on their economies.

All of this would suggest that the European Central Bank has its work cut out for itself. Not only might it need to expand yet again its quantitative easing program to counter the Euro’s relative strength and to provide support to a flagging European economy. It might also need to stand ready to buy large quantities of Italian and Spanish bonds as well as to provide support to their troubled banking systems. It might need to do so with a view to avoiding a potential breakup of the European Monetary Union.

Social Media Auto Publish Powered By :