Let’s start by remembering that the creation of the euro, in 1999 based, was based as much, if not more, on politics than on economics. This resulted in an acceleration of a dogmatic construction of Europe for too long where momentum has become an objective in itself.
As repeated again and again in this blog, the common currency was flawed from the beginning: Germans wanted the ECB to fight inflation only and they got their way whilst the French wanted to dilute as much as possible the German powerhouse, and they got their way with all the club med countries joining (including the ones not matching the Maastricht treaty criteria). As a result, there has never been any will to enforce the Stability Pact, France being at the forefront of countries not abiding by its commitments (the third worse country in terms of budget deficit during the growth years of 2002-2008 with 3.9%, behind Greece 5.5% and Portugal 4.5%).
For the past few months, the European elite has been in denial and therefore always behind the curve of events and refused to face reality: Greece is bankrupt; Portugal and Spain are getting closer, then Italy, France and Belgium following at a short distance. The only answer was to stigmatize so-called speculator and to bring rescue plans that could not work since the debt burden is too heavy. Even the latest plan represents less than 10% of the EUR 7,700 billion eurozone sovereign debt for the 10 largest countries in 2010.
After last weekend's meeting in Brussels, some European leaders, and in particular Nicolas Sarkozy, the French President, had only to say that they were going to take on speculators ("we will confront speculators mercilessly"): less bragging and more proper action, please; their "success" lasted a few hours on Monday morning when the euro recovered to 1.3 for a short period of time, to fall back Friday at 1.2375 at time of writing (5:15 pm GMT). It does not seem that the ECB intervened, only the Swiss central bank in the morning to defend the 1.40 mark.
The euro will continue to fall (the PPP is in the 1.15-1.17 region and there is no technical strong support till there), until the eurozone credibility is restored. There is no way that it can currently recovered with:
- The worse performing economic zone worldwide since the beginning of the euro
- Austerity measures across that will compound the problem and risks the eurozone falling into a deflation spiral
- Low interest rates nowhere ready to go up
- Inflation directed policies will be set in over-indebted countries to crawl their way through this adjustment (yet the ECB buying in the secondary market any euro denominated bonds is quantitative easing)
- The need for an undevalued currency to stimulate their economy
- discordance between European leader (see El Pais newspaper this morning stating that Nicolas Sarkozy arm-twisted Angel Merkel by threatening to leave the euro - later denied)
Even if the euro benefited German exports, my view is that Germany will leave the single currency, and create a DM zone that will be joined by budgetary virtuous countries (from Austria to Finland, including Flanders if Belgium collapses, which is not out of question). There is no way that a single currency can work with such economic, fiscal and social discrepancies between countries. There is also a contradiction keeping the eurozone as it is today: a fall of the euro, which is needed for Club Med countries to regain competitivity and adjust themselves to deep and painful reforms, will not change the trade balance (or marginally) for weak countries, until the most competitive ones are in a strong currency zone - most of the trade is done intra-eurozone.
The Franco-German axis that so far led the construction of Europe is broken. There is now a clear opposition between France with a dogmatic approach of the EU and eurozone construction on the one hand, and a pragmatic Germany on the other hand. This just reflects the absence of in-depth economic, fiscal and social reforms in France, the opposite of Germany, that resulted into an uncompetitive economy. The European Commission proposes to check national budgets ahead of going before parliaments: too late and frankly the EC has no credibility (look at Baroso tenure as President, who is almost as dreary as von Rompuy); all this resembles to panic hole plugging, but they are too many.
Germany (and German taxpayers) is getting fed up to pay for club Med Europe and the Common Agricultural Policy (46% of the EU budget!) that has benefited France for so long and is due to renegotiation for 2013 (Nicolas Sarkozy indicated that it would be a casus belli).
By the way, we are talking austerity with civil servants across Europe, let's not forget the fat eurocrat cats in Brussels and Luxembourg.
To have one single chance to save Europe (we should) and the euro (should we?), start right now discussing with the IMF, creditors, the US, China and debtor countries to reschedule their debt. And devalue the euro.
Of course, we should not forget banks that are the happy holder of devalued/junk sovereign debt. Last Friday, the interbank market in Europe was freezing again: we are not out of the woods. European banks are in very bad shape, and I would not be surprised that some are near bankruptcy.
Short the euro and European banks, even if they are crowed trades. The one danger is a coordinated action by central banks in the FX markets to squeeze euro short sellers. This would however have no lasting effect until the roots of the problem are properly addressed. Watch emerging markets stocks that could be hammered during this crisis and may provide fantastic buy opportunities; same for mining and energy stock.
Worth watching this video on the Plaza accord.
Worth watching this video on the Plaza accord.