The Not-So-Strong Euro

Mike Shedlock
Posted: Aug 19, 2012 12:01 AM

Reader Toney writes ...

Hello Mish,

Please consider writing a piece on your blog explaining why EUR USD is not more eroded.  It would seem that given the Euro zone's current troubles, the Euro would not have remained as strong as it has.

I read your blog religiously.

Hello Toney, would not exactly call 1.23 "strong" but certainly there is room to fall. So why is it just sitting?

Technically, the euro is at the lower end of a trading range and that would tend to bring out some buyers and some short covering. From that aspect, one might even wonder why the bounce has been anemic. A weekly chart will show what I mean.

Euro Weekly

click on chart for sharper image

Technically, the euro can plunge a long way if that weekly support gives way. Will it?

Key Questions on Breaking Up

Right now the currency market is torn between whether or not the eurozone stays intact, and if not, what countries leave and how.

A eurozone breakup is easily the primary driver. How the break-up occurs is unresolved.

The Eurozone Cannot Possibly Survive Intact. As I have pointed out, The Problem in Europe is Arithmetic, Not Confidence.

Will a break-up be orderly or disorderly? Will Germany leave or will Spain and Greece leave? Those are the key questions and right now I do not have an answer (and no does anyone else either).

If Germany leaves, Deutschemark will soar and the euro will plunge. Moreover, if Spain and Italy leave in a disorderly fashion there might easily be a currency crisis of some sort, also forcing the euro lower.

However, if Spain and Italy leave in an orderly fashion, the euro could strengthen.

Right now, the market seems to be prepared for the "Grexit" and it does appear that Greece will leave in a somewhat- orderly fashion. Should Greece leave without causing a mess, the markets are likely to take that as a positive for the euro over the short-to-intermediate-term.

I am roughly neutral on the euro for the short-term.

A secondary factor is ECB printing and here the results are counter-intuitive. Every time the ECB comes up with a major program such as the LTRO, the euro has strengthened.

That suggets the market favors keeping everything intact, even though it adds long-term pressures. For example, the LTRO made it easy for German and French to unload Spanish debt (a good thing for banks in those countries). However, the buyers of that debt were Spanish banks who ultimately will be left holding the bag.

Short-term the LTRO was stabilizing, long-term it is going to increase the pressure on Spain to leave.

Notice how screwed up things are. The normal fundamental factors in play regarding currencies are interest rate differentials, balance-of-trade flows, and concern over budget deficits. The US would not score well on those points, but clearly these are far from normal times.

The euro now depends on when, in what order, and how disorderly a break-up will be.

Yesterday, Finland's foreign minister said "Finland must face openly the possibility of a euro-break up"

“We have to face openly the possibility of a euro-break up,” said Erkki Tuomioja, the country’s veteran foreign minister and a member of the Social Democratic Party, one of six that make up the country’s coalition government.

“It is not something that anybody — even the True Finns [eurosceptic party] — are advocating in Finland, let alone the government. But we have to be prepared,” he told The Daily Telegraph.

“Our officials, like everybody else and like every general staff, have some sort of operational plan for any eventuality.

Mr Tuomioja’s intervention is the bluntest warning to date by a senior eurozone minister. As he discussed the crisis, the minister had a copy of the Economist on his desk. It had a picture of Angela Merkel, the German Chancellor, reading a fictitious report entitled “How to break up the euro”, with a caption: “Tempted, Angela?”

“This is what people are thinking about everywhere,” said Mr Tuomioja. “But there is a consensus that a eurozone break-up would cost more in the short-run or medium-run than managing the crisis.

“But let me add that the break-up of the euro does not mean the end of the European Union. It could make the EU function better,” he said.

What Consensus?

I have to wonder "what consensus" the Finnish foreign minister is referring to when he says "eurozone break-up would cost more in the short-run or medium-run than managing the crisis".

Consensus of nannycrats? Of politicians who bet their career on saving the euro? Of the Southern eurozone countries?

His second thought is far more believable: "Break-up could make EU function better".

Indeed nearly anything would be better than the eurocrats headed by Eurogroup president Jean-Claude Juncker and European Commission president Jose Barroso.

Finland Distances Itself From Tuomioja’s Comments

No doubt Tuomioja’s comments raised quite a stir because today Finland's European affairs minister stated Finland is totally committed to the euro.

Finland is totally committed to the euro, its European affairs minister said following comments from its foreign minister that the country was preparing for a break up of the single currency.

“Foreign minister Tuomioja’s statement in no way reflects the Finnish government position,” said Alexander Stubb, highlighting deep divisions within the coalition government. “Finland stands 100pc behind the euro,” the European affairs minister added.

He was speaking after foreign minister Erkki Tuomioja told The Daily Telegraph “we have to face openly the possibility of a euro-break up.”

Mr Tuomioja, a member of the coalition’s Social Democratic Party, said that Finnish officials had an “operational plan for any eventuality.”

Mr Stubb, a member of the centre-right Kokoomus Party, said his colleague had probably spoken in a personal capacity. “The government’s position is very clear: we stand pro-European and we stand to work, to improve the situation in the eurozone,” he said.

The positions of preparing for a break-up and being committed to the Euro are not mutually exclusive. However, the more talk there is of a break-up, the more that path becomes acceptable.

The point is moot however. The Problem in Europe is Arithmetic, Not Confidence. The Eurozone Cannot Possibly Survive Intact.