Euro Future – Coasting To Oblivion Perhaps?

The Euro is “doomed” said one US based analyst whilst, on the back of the EUR720bn stabilisation package announcement last week, another pointed to the cost of securing the future of the Euro being “far too high”. Even former FED Chairman Paul Volcker is reported to have implied we are watching over the disintegration of the Euro. No laughing matter then and like never before in its twelve year history the Euro is receiving a battering. Clearly Euro bashing that we see before us now is unlikely to end anytime soon. But while we may yet see the Euro edge closer toward dollar parity I personally believe that it is far too early yet to even begin to write off the great European currency experiment.

Last week when the EU and IMF authorities belatedly acted to do something a little more than paper over the cracks of the Greek sovereign debt crisis and a couple of days later, when ECB awoke to reality finally reversing the long held opposition and distaste for distressed asset purchasing, it seemed for a short while that sovereign debt concerns might even begin to head off in the right direction. Perhaps they might have had it not been for the manner in which the EU and Eurozone authorities had in the previous weeks shocked markets in their ridiculous attempt to cope with the specific Greek crisis. By ignoring the contagion threat and by ignoring the potential strength of what external rating agencies could still do plus by ignoring the damage that the Greek crisis was already doing to market sentiment across the world EU and Eurozone authorities exposed a fundamental weakness in the integrity of the Euro. This will take years to put right.

However we caution that Eurozone isn’t the only area guilty of having member states that carry huge public sector deficit and debt concerns or for that matter, run with ongoing levels of political uncertainty. The US for instance carries a more than its fair share of both, so too the United Kingdom and for all its strengths Japan is hardly flushed with cash. Why then hammer the Euro? Is it because as effectively the newest global currency markets see this one as being made up of little more than a class of ungovernable unruly schoolchildren? There may be something in this last remark.

That said given that the Greek crisis exposed a degree of unacceptable arrogance of the EU and Euro authorities particularly in finding that after twelve years of life no one it seems had thought to bother about having a plan ‘B’ should something go wrong we should not be surprised that the Euro is being hardest hit amongst global currencies.

With a general dislike that markets have for uncertainty the best that can be said of recent events is that trashing the Euro has at least brought some degree of respite for some other currencies. Indeed, deservedly or not the dollar has been enjoying something of a rally of late although as in past we would caution that any respite of long term dollar decline may well be relatively short lived. The dollar is not the only currency that has benefited at the Euro’s expense either as even sterling has rallied casting aside equally wide market concerns over how deep and how fast the new UK political authorities will go in their attempt turn the UK deficit around! But then the UK is but one country as opposed sixteen meaning that its problem is seemingly self contained and manageable. The same may be said of the dollar and the US; Japan and the US and so on. And thereby hangs the problem – twelve years ago when world economies appeared on an upward track and the then smaller EU appeared managed and disciplined the Euro quite naturally appeared as a very good idea. It was but now when the realisation is all about how we address the years of living beyond our means and the chickens of overspending have all come home to roost it may not look like such a good idea.

There can of course be no automatic guarantee that the Euro will survive the current crisis but on balance although it seems to us that we could see the Euro close to dollar parity again we should not begin to write off the currency if and until it should get to that stage. Obviously we hope that it does not for the simple reason that the complications are so large and with nothing to replace it the implications for the rest of the world of Euro failure would as far as I am concerned be far too great to contemplate. Equally possible is that if they throw the towel in on the Euro they might also be throwing the towel in on the EU.

Market punishment of the Euro these past few weeks has been an inevitable consequence of the politics surrounding the Greek sovereign debt crisis. It is of course government budget deficits that drive concern on debt. Such is the pressure of concern that Spanish and Portuguese authorities have in recent days announced further quite severe fiscal moves aimed at bringing budget deficits back into line a few years from now. We may hope that they succeed too. Meanwhile Ireland acted many months ago and we are now seeing countries such as Italy act to convince markets and Euro authorities of their intention to operate a far more disciplined approach. Seemingly on its own Germany is also pushing for a complete Euro area deficit rethink that would inevitably lead to very much tighter fiscal restraints. But while the underlying message of what is clearly intended within the German proposals should be welcomed as maybe being sufficient to confirm that the authorities are determined to ensure never again will the Euro be allowed to be so exposed by the failings of one member state they are not without specific consequence. For a start we may reasonable expect that already low levels of Euro area growth will be further slowed to the point of maybe seven or eight years of little or no visible GDP growth. There is also the issue of affordability for member states and the political consequences of over tightening. Against this there can be little doubt that assuming the Euro area stays much as it currently is in membership terms I guess that markets would have to see the stability achieved as a positive indication that the Euro did after all have a future. My big worry against those talking down the Euro is that they are possibly talking back to even greater unknowns.

Assuming that the Euro remains low against both dollar and yen it is quite possible to envisage that Euro area exports would rise. But while such thoughts are clearly positive assuming the global economy is not further hurt by the impact of Euro concern so too will the cost of imports rise. That has a corresponding concern on the impact that a lower Euro and rising imports might have on inflation. Given that even if deemed appropriate by the Euro authorities raising interest rates would add fuel to the flames and further slow economic recovery we doubt that the interest rate weapon will be used by the Euro authorities over the coming year.

Earlier I touched on the question of how long before the Euro might indeed find parity against the dollar? Soon enough is the probable answer to that but on the other hand if the EU and Euro authorities can get their respective discipline acts together maybe not at all. Certainly in the absence of a miracle cure to the wider Eurozone area sovereign debt and deficit issues the Euro is headed down below $1.20 and probably over the next month. Much of course will depend on market attitude as to how they perceive the various national measures being proposed are put into effect, how quickly and indeed, how they are received by those that will inevitable suffer. It will also depend on ECB observation and of course on whether France and Germany as the leading Euro area members are talking as one.

The wider and perhaps far more serious question being asked in some quarters now though is as I said earlier, whether this unfortunate period in the history of the great European currency experiment could in fact also be marking the beginning of the end for the Euro itself? I hope not. Indeed, imperfect as it is and imperfect as the whole European ideal sometimes appears I have to conclude that whilst I for one happen to be delighted that we in the UK are not part of the Euro that the reality is that we are in fact better off with both Euro and the EU than we are without either of them.

But given that the jury on the Euro may soon be about to go out let us at least hope that those that have helped make the specific Eurozone sovereign debt crisis worse by inept economic management and lack of fiscal discipline plus by failed communication have learned obvious lessons. True, long term survival of the Euro and of market and political sentiment will not have been helped by the spat between the two largest Euro economies – France and Germany. Even if hardly being serious that French President Nicolas Sarkozy would even dare to say that France might abandon the Euro unless Germany dropped its hostility to the backstop EUR720bn stabilisation safety net last week was enough to send a very nasty chill down the spine. That it took a crisis of market confidence on Greece to expose a wasp nest is of course regrettable although better now perhaps than even later. However although it could be said that France has laid down a gauntlet that can hardly be ignored and that Germany has resisted open ended assistance for Greece without ensuring that necessary fiscal disciplines are in place we do not believe that there are dangers of the Euro imploding yet.