Back then, it took several billion to buy a loaf of bread. Another couple billion to purchase eggs, fabrics, sugar – basically anything you needed.
The price of everything was doubling almost every single day. Workers were paid three times a day to keep up with rising prices.
Inflation was rising by 29,500%…each month.
This was the reality in Germany, 1923. This traumatic event has gone down in history as one of the worst cases of hyperinflation ever. It also made the Germans almost paranoid about fighting inflation ever since.
No wonder the recent spike in commodity prices is already making Germans a little nervous.
And that has important consequences for the currency market. Monetary authorities in Europe are getting ready to fight inflation. For those of us who are ready, it will mean some killer opportunities in certain currencies.
An Economy Running on All Cylinders
The present-day Germany is booming. That’s the good news. The bad news is inflation is also on the rise.
Inflation measured by the Consumer Price Index is already higher than the European central bankers would like. It’s already above the European Central Bank (ECB) target. And official data actually underestimates the problem.
Unicredit Bank, one of the major banks in Europe, adjusted the official inflation by giving more weights to goods people buy most often, such as fuel, food and clothing.
This methodology makes perfect sense. It’s more likely to reflect the true level of inflation. The bad news is they concluded prices in Germany are rising almost twice as fast as the official rate.
Last month, the employment situation improved three times faster than the market expected. The unemployment rate is now reaching a two decade low.
German unions are already pushing for bigger wage increases. The country’s IG Metall union, for example, has asked for a 6% increase for workers at companies such as Volkswagen.
This demand for higher wages really scares the ECB. And the rising commodity prices don’t make things any easier for the central bank.
History is Likely to Repeat Itself
We’ve seen this before. So we can visualize how things will play out.
In 2008, there was a major rally in commodities, with oil spiking all the way to $140. At that time, the euro also surged on expectation of higher interest rates.
Higher oil prices increased the fear of inflation, forcing the ECB to hike rates in July. As you can see in the chart, it didn’t take too long for the euro to tumble.
Last Time ECB Hiked Rates, the Euro Took a Big Dive
Shortly after raising rates, the financial crisis escalated, forcing the ECB to cut rates to a record low. History may be about to repeat itself.
If commodities keep rising, the threat of inflation will escalate in Germany. The ECB may just make the same mistake it did in 2008, hiking rates at the wrong time.
While in 2008 the global financial crisis was behind the euro decline, this time I suspect internal imbalances will do the job.
Who Cares About the PIGS?
With prices of commodities skyrocketing, the inflationary pressures will only get worse.
That’s why the European Central Bank has already signaled it will raise interest rates if inflation fears escalate. And that’s what has been driving the euro higher recently.
Higher interest rates would be very appropriate for a booming Germany economy. But it’s certainly not appropriate for nations that are slumped in recession, such as Greece.
While employment in Germany keeps improving, the unemployment rate in countries like Greece and Spain has more than doubled in recent years.
But for the European Central Bank, it doesn’t really matter. They will always do whatever is best for Germany.
Higher rates will make the life of the PIGS (Portugal, Ireland, Greece, and Spain) a whole lot more complicated.
With austerity measures still biting, higher interest rates is the last thing those countries need. It may just send them into a very nasty deflationary environment.
Saving Germany Will Hurt the PIGS, and the Euro
That’s the problem when you have to use the same monetary policy to countries in very different situations.
It’s like giving the same insulin shot to two different patients, one diabetic and one healthy. The injection will do wonders for the diabetic, but it may just kill the otherwise healthy person.
So the European Central Bank has to decide between fighting inflation in Germany and saving the troubled nations. With rising commodity prices, a booming German economy, and the ECB’s natural inflation phobia, the Central Bank will most likely pick the first option.
That just confirms my view that the euro is going to fall from here. Be on the lookout for shorting opportunities.
Bottom line: Although higher rates will push the euro higher in the short-term, in the long-term, it will come back to bite the troubled nations. Stay short the euro!
Editor, Exotic FX Alert