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The Death Of The Euro?

March 12, 2015

Death of the Titanic

Artist: Matthew Chapman from Matthew Chapman’s Titanic Tribute 100 years, an exhibition of paintings, drawings and installations

Is the Euro the Titanic? The question may be rhetorical but oddly, there are comparisons. The Euro “set sail” on January 1, 1999 to great fanfare as it replaced the European Currency Unit (ECU) which was a basket of the currencies of the European community (EU). Up until the Euro came into being, the members of the EU continued to use their national currencies. The ECU was an accounting unit only. Only 19 of the 28 EU members use the Euro as currency. Two of the most notable exceptions of EU members who do not use the Euro are Great Britain who continues to use the British Pound and Sweden who uses the Swedish Krona. The Euro is also used by the institutions of the EU as well as four mini states that all lie within Europe (Andorra, Monaco, San Marino and Vatican City).

Charts created using Omega TradeStation 2000i. Chart data supplied by Dial Data

One could argue that the Euro hit the “iceberg” in April 2008. That was the peak at 1.5980. The financial panic of 2008 saw a rush into the US$ as a safe haven but as 2009 got underway the Euro began to climb again as everyone believed that while there was some rough times ahead the worst of the crisis was over. But the Euro zone was developing too many systemic problems. The population was aging, the birthrate was stagnant, and immigration was a problem primarily because immigrants were for the most part poorly integrated into the broader population. In addition, the EU has too many regulations coupled with a rigid labour market and overly large public sectors. The EU itself is a centralized bureaucracy with a number of different councils, commissions and agencies. The EU is governed by an elected Parliament with the number of seats each country gets is based on population. Germany, France, Italy and Britain dominate the European parliament

But what really dragged the Euro zone down was failure to consolidate all of the member’s debt. While they created a central bank, the ECB, central banks that had been an integral part of each individual member not only continued to function they could continue to act as a central bank. The central bank of each country in the EU is member and shareholder of the ECB. Once again, Germany, France and Italy dominate the ECB as the largest economies. The Bank of England (BOE) is not a member because Britain does not use the Euro. The ECB is responsible for monetary policy for the zone but does not have the powers of the US’s Federal Reserve. The financial strength of each country varied sharply from strong countries like Germany, France and Britain to weaker countries like Greece, Portugal and eventually the eastern European countries that joined the Euro zone later following the collapse of the Soviet Union.

The EU and the Euro currency are dominated by Germany and to a lesser extent by France and Italy. Britain is also a dominate economy as a member of the EU but Britain does not use the Euro as currency. Germany as the dominate economy, effectively uses the rest of the EU to export its goods to. Using the Euro Germany received the equivalent of a devaluation of its former currency the Deutschemark. Not so for many smaller peripheral countries where the switch to the Euro meant effectively a huge appreciation of their currencies. Strong export countries like Germany, Italy, the Netherlands, Sweden, Norway and Denmark thrived while others in an attempt to catch up to the standards of the stronger European economies borrowed money when what was needed was huge structural reform.

The Eurozone crisis or the Euro crisis as some refer it got underway at the end of 2009. The crisis is also referred to as the European sovereign debt crisis. After piling up huge loans without the accompanying structural reforms to their economie…and suffering the after effects of the 2008 financial panic a number of EU states were unable to either repay or finance their debt without a bailout from the ECB, the IMF and the EU commission. These three were nicknamed the “Troika”. The states faced sharply rising interest rates, huge structural deficits, and mostly a high debt to GDP ratio. The countries most impacted became known as the PIGS (Portugal, Ireland, Greece and Spain). Others soon joined them (Cyprus, Italy). Of late I have been reading that Austria could be the next Greece.

The Euro’s “sinking” phase was underway from 2009 to 2014. Whenever the ongoing Euro crisis appeared difficult to resolve the Euro fell. When short-term solutions appeared to be found the Euro rose. Interest rates were lowered, refinancings took place, countries had to undergo structural reform and austerity in order to try to stabilize themselves. Contagion also spread as Italy and some of the smaller peripheral eastern European states began to suffer as well. Eventually even France was coming under pressure as the French economy has shown signs of sliding into recession.

The Euro zone is falling into deflation. Consumer prices have turned negative in a number of Euro zone countries. A number of countries have moved to negative interest rates. There is an estimated $1.7 to $2 trillion worth of bonds in the Euro zone trading at negative yields. Even German bonds are trading at negative yields. None of this is a positive development and suggests that the Euro has considerable further to fall.

Politically Greece and the risk of the “Grexit” is not the EU’s major potential problem any longer. Polls show that a referendum on Great Britain remaining in the EU could fail. The British Pound has been hit hard on this news. It has raised talks of the “Brexit”. But could there also be the “Frexit”? Ok I haven’t actually seen that term as I just made it up (“Frexit” – France exit from the EU and the Euro). In France, the xenophobic far right National Front headed by Marine Le Pen is leading in the polls and could form the next government. The National Front wants to pull France out of the EU and the Euro and return to the French Franc. There are a number of nationalist right wing parties in Europe and many of them are anti EU and Euro. All have been gaining in popularity.

The Euro began its “death” spiral back in March 2014 when it topped at 1.3950. Today the Euro is trading under 1.06 and falling. The decline has been rapid and appears to be picking up speed. The Euro formed what appears as a descending triangle pattern prior to the collapse. The triangle pattern suggests that the Euro has the potential to fall to objectives at 0.82. That is still another 24% from current levels.

There are many saying that the Euro is doomed. That may be. Forecasts for the end of the Euro range anywhere from 2018 to 2022. If the Euro were to collapse because of countries exiting the EU and the Euro it would go down as one of largest currency collapses in history. What the cost to the EU and the Euro zone plus fall out to other countries and global markets is unknown. But the collapse of a currency such as the Euro cannot be idly dismissed. Other currencies have collapsed such as Zambia and Zimbabwe. But their impact was largely local. The Venezuelan Bolivar could well be headed for collapse as well. Its collapse could be felt beyond Venezuela.

A collapse to 0.82 would not be the end of the world for the Euro. In 1985, the adjusted Deutsche Mark expressed in Euros fell to the equivalent of 0.58. That set up the Plaza Accord of September 1985 to bring down the high value of the US$. The new introduced Euro fell to near 0.83 in July 2001. And that was not long after the introduction of the Euro in January 1999.

Given negative interest rates in the Euro zone it should not be a surprise that Euros are being sold for US$. The question is where are the US$ going? The US stock market and bonds have both been falling of late. While gold prices have fallen roughly 3% in US$ so far in 2015, gold is up over 10% in Euros. Gold is also up just under 7% in Cdn$, just over 1% in British Pounds and flat in Japanese Yen. Gold in Russian Rubles is surprisingly flat so far in 2015 but remains roughly doubled from where it was on December 31, 2013.

The Euro has support at 1.05 and 1.00. But a breakdown under 1.00 could start a panic. The simple reality is that the Euro zone remains a mess with too many countries struggling to meet their debt obligations if even they can. Couple this with the desire of some to exit the EU and leave the Euro. No matter what the ECB does to try and mitigate this, events could potentially overwhelm the central bank. The central bank wants to inflate and instead they are getting deflation.

Meanwhile the US$ continues to soar and already there is considerable grumbling in the background. The sharply rising US$ is hurting exports and it is negatively impacting the profits of its multinationals as they have over half their earnings in foreign countries. A rising US$ rather than exhibiting strength is most likely signaling coming deflation in the US as well.

Already recent PPI and CPI releases have turned negative. And despite the so-called strong jobs report numerous other economic numbers are actually sliding. The US’s two main competitors, Europe and Japan are both sliding into recession and deflation. China is slowing and they have a very vulnerable banking system. The US is not immune. The US$ most likely has further to rise before there are cries to bring it down. That has happened before in 1985 and 2001. Should this time be different?

The Euro is slowly dying. It has been a slow death. Like the Titanic, it initially appeared to not be a problem and assurances were given that things were under control. But eventually the people on the Titanic realized that the ship was going to sink. It was at that point that the panic began. The recent collapse of the Euro is a signal that things are not under control and indeed could be getting worse. The death of the Euro? It remains possible given everything that is developing or underway. But like the Titanic the real panic will not hit until towards the end. The Titanic’s end came swiftly? Will the Euro do the same?

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