The euro is a much sicker currency than it looks

By MoneyWeek editor-in-chief Merryn Somerset Webb Dec 12, 2011

Merryn Somerset-Webb

Share with
friends:

Comments (9) Print this article

Looking for a safe haven? You’ll have to go a long way to find one, reckons Ed Yardeni of Yardeni Research. He says anyone seeking fiscal discipline, small government and low taxes should give up on earth and head for Kepler-22b, a planet just discovered by Nasa. It has a pleasant sounding surface temperature of 22 degrees, might have a water supply and is, as far as we know, currently debt free. The tricky bit of course is getting there – it is 600 light years away. But can the journey be any more difficult than the route out of the eurozone crisis?

Still, if there were fiscally responsible alien life on Kepler-22, it might not think the climate’s too bad in Europe, either.

Why? Because, as many readers have pointed out to me – mostly on empty-pocketed returns from holidays in Italy and Spain – the euro is a bizarrely strong currency. Britain’s middle classes have long assumed that the silver lining to the implosion of the eurozone would at least be cheap skiing trips. But that’s just not happening.

Look at the euro against the dollar and you will see that the exchange rate has been moving in roughly the same range for the last three years – despite the fact that half the world seems to think the currency is on the verge of extinction.

So what’s going on? It might be that the euro is being supported by institutions repatriating capital to shore up their balance sheets – selling dollars and pounds to buy euros. But there is probably more to it than that.

In a world where most Western countries are fighting to devalue their currencies, the euro arguably looks less bad than it would otherwise. The US and the UK have made it clear that they will print unlimited amounts of money should they see the need. Europe – or the European Central Bank (ECB) – hasn’t.

As a whole, Europe also doesn’t have the same nasty trade deficits as the US and the UK. Add that to its relatively high interest rates (we live in a world where 1% is high) and the euro – even if many of the countries it represents are basically bust and its banks are in a funding crisis – looks like a hardish currency in a world awash with quantitative easing.

Sign up for a 3-week FREE trial of MoneyWeek
and get the following free as well

"The only financial publication I could not be without."
John Lang, Director, Tower Hill Associates Ltd

This leads to a second possible reason: that the euro is trading as something of a proxy for a currency of the stronger nations. There are two assumptions behind this argument. First, if the eurozone holds together, it will do so because fiscal union brings austerity and a new era of creditworthy nations living under sound money. Second, if that doesn’t work out and the eurozone breaks down, it will divide into two parts: the strong (led by Germany), and the weak.

The strong would get to keep the euro and the weak would leave it behind.

So by holding euros today, you are betting that you are in fact holding a kind of new deutschmark.

This makes sense at first glance. But not at second.

If the eurozone doesn’t hold together, it is hard to see how the countries currently considered elite would stay that way. Let’s not forget that, pre-euro, Germany was the sick man of Europe. Given how dependent the growth of its export economy has been on the existence of the euro, who’s to say what the end of the euro might do to it? That’s before we start worrying about the round of banking crises likely to follow currency collapse.

And what if the euro sticks together? Levels of sovereign debt are now so high that it no longer matters how many meetings are had on the matters of fiscal union and austerity – it won’t be enough. In the end, one way or another, the ECB will have to pick up the pace of debt monetisation (creating money to buy national debt), just like the Fed and the Bank of England.

Eventually, the euro, like everything else, will be valued according to the strength of its weakest link: think more drachma than deutschmark. A reason perhaps to leave booking your 2012 holidays until the last minute.

• This article was first published in the Financial Times

Comments (9)

Published in Currencies | More articles by Merryn Somerset Webb

Share with
friends:

Related articles

Comments

Leave a comment

  • 1. Willie

    (13 December 2011, 11:33AM)  Complain about this comment

    Or consider the idea of Germany leaving the Eurozone and returning to the Dmark leaving the rest with a heavily devalued Euro so we may eventually get cheap holidays in the French Alps and the Med.

    Pushing Germany out of the Euro may become a very attractive alternative to having German imposed austerity for a number of med countries.

  • 2. d.andre

    (13 December 2011, 11:53AM)  Complain about this comment

    One way or another the Euro has ruined Europe. Greece was no longer competative and lost much of its tourism and the money it was lent with easy credit appeared to be unlimited . Now they are suffering extreme poverty.
    It reminds of the setting up of Oxfam - as I understand it it was set up after the war to support Greece; perhaps we need to go back and set similar charities to support the struggling Euro countries.
    Oh, sorry, I forgot we are all poor these days!
    What a mess!

  • 3. IJ

    (13 December 2011, 12:24PM)  Complain about this comment

    I've had so many 180 degree turns on this issue of who is most likely to leave the Euro, so am liable to change my mind tomorrow. But right now I just can't envisage a scenario where Germany leaves the Euro, and the ECB, based in Frankfurt, prints money for the rest. As for the question of cheap holidays, even if Germany were to leave the Euro i wouldn't hold out too much hope. Given the horrific state of the UK economy, and a central banker no less shy to print than Bernanke, why is sterling necessarily better than the Euro, even without Germany in it? If the ECB ends up printing, won't the BoE just print more?

  • 4. K.A.

    (13 December 2011, 01:54PM)  Complain about this comment

    @ IJ. I agree that the Germans do not want to print money so that they can maintain the fabulous buying power of their Euro, but, like King Canute, even the Germans cannot stop the waves of debt running up the shore towards them. The ESM is meant to be the dyke that keeps the sea/debt out, but guess what? Its made of sea/debt.
    I reckon the Germans will cling onto their exchange rate for as long as possible, while the potential defaults and bank collapses build up around them. Merkel will talk the talk, and meanwhile take her country right up to the edge, to have a long hard look into the Abyss, before capitulating on money printing.

  • 5. Max

    (13 December 2011, 01:54PM)  Complain about this comment

    The Euro is 'bizarrely strong' against what? Pound or US Dollar? The truth is that every country, including Switzerland is heavily inflating. The Euro is certainly very bad. But to me, the Pound and the US Dollar look even worst. Other than in the UK and the US, the Euro countries cannot agree on printing their way out of the problem. Although this opposition against inflation in the Euro is unlikely to prevail, it is better than having no opposition in the first place.

  • 6. Brian A

    (13 December 2011, 01:59PM)  Complain about this comment

    The EU like a giant ice sheet seems too great to fail but is moving towards hot water and those on board willeventually understand their error.
    Cameron will be placed under enormous pressure not least by his own civil service in Brussels but he must hang tough.
    I would not like to see us leave the union but if the pack unite against us (to hide their unresolved problem) we may have to.

  • 7. Daytona

    (14 December 2011, 09:54AM)  Complain about this comment

    "The strong would get to keep the euro and the weak would leave it behind. "

    Hmmm... that's a big assumption to make.

    Weren't you, or was it someone else, proposing that the sensible thing was for the countries that could least afford the cost of currency change to keep the Euro, whilst the richer countries incurred the costs of creating their own currencies again.

  • 8. Mike

    (17 December 2011, 11:49AM)  Complain about this comment

    The Euro is within 10% of the $ price it was when it first started in 1999.

    So comments about its strength or weakness are : irrelevant.

    See the ALL chart at
    http://www.ecb.int/stats/exchange/eurofxref/html/eurofxref-graph-usd.en.html

  • 9. nev

    (18 December 2011, 10:26AM)  Complain about this comment

    I cannot imagine how the Eurozone is going to avoid this car crash. More to the point, neither can the rating agencies.
    If Merkel and Sarkozy simply will not accept the failure of the experiment it will fail explosively.
    2012 may well be a good year to be in cash.

Leave a comment

This will be the name displayed with your comment.

This helps us verify comments are genuine. It will not be displayed anywhere on the site and is stored confidentially.

Please keep your comment within 1,000 characters and relevant to the main topic. We encourage healthy debate, but we don't allow insults or bad language. Anything off topic or unpleasant, we'll remove. Enjoy the conversation! Thank you.

captcha To prevent spam-related comments please enter the characters shown in the 'Captcha' box to the left.

By leaving a comment you accept our terms and conditions.


FREE - MoneyWeek's daily investment emailJohn Stepek

Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.

>