Why Hasn't the Euro Tanked? (Part 1)

With all the tumult over the future of the euro and the Eurozone the last couple of years, many are surprised the currency has continued to hold up so well. The various debt problems in the bloc have threatened the very existence of the currency, at least in its current form. If the core is unwilling to finance the debt of the periphery, or if Spain and Italy are too big to fail, or if Greece is a lost cause and bound to exit, then why hasn’t the euro fallen further?

In fact, many prominent economists have even called for euro parity with the US dollar. Thus far, however, we’ve yet to see this prophecy fulfilled. Contrary to many perplexed euro-bears, there are in fact several reasons the euro has persevered.

One justification is that it shouldn’t be considered euro resiliency against the dollar, but more that both currencies are weak relative to other assets. Indeed, if you compare the spot return on dollars (via the DXY currency basket) and euros (vs. dollars) over the last five years to that of gold, you’ll see the dollar and euro returns mirroring each other in opposite directions, while gold has massively outperformed both. It doesn’t hurt that the Fed has been remarkably dovish with rates at zero and endless stimulus, while the ECB has kept its hawkish demeanor even throughout their crisis.

Despite recent trouble with the euro area, the constituents are still largely significant global trading partners. Germany, for starters, is the third largest exporter in the world. When the euro loses value, this acts to make European exports cheaper to the rest of the world, stimulating exports and inducing more purchases of euros. This has helped the Eurozone maintain their trade surplus regardless of the crisis.

Normally when a country’s debt comes into question, investors will sell that country’s bonds, convert the currency and invest in safer assets. Recently however, when peripheral bond yields have risen, German bund yields have fallen. It's well known that German bunds have now reached historically low yields. In other words, it seems that instead of dumping the euro after selling peripheral bonds, investors are reinvesting (at least some of) their proceeds in German debt. Since German debt is safe, the market seems to reason, there is no need to convert to a different currency to reinvest.

There is of course also the prospect that the core (ie Germany) will eventually agree to a pooling of debt, but first wants to establish as much austerity within the periphery as possible. If they were to accept Eurobonds right off the bat, they’re convinced this would create a moral hazard and no one would take the austerity measures seriously. Although they may eventually reach this extent of fiscal integration, it doesn’t appear to be their master plan. Rather, they seem to be inching towards it (perhaps inadvertently) with every subsequent concession to the periphery.

(…To be continued next week in Part 2)

 

Let's do a thought experiment here:

1.) If the ECB prints $3 Trillion in Euros and stuffs it in their walls, it has no impact on inflation. Or on the value of the Euro.

2.) If the ECB prints $3 Trillion in Euros, gives it to European consumers, and they promptly save it and stuff it under their mattresses, it has no impact on inflation or on the value of the Euro.

3.) If you hold Eurozone debt because you don't think the stock market is a good bet and don't want to spend money right now, having the ECB monetize your Spanish or Italian bonds doesn't necessarily mean you're going out and buying a new SUV and redoing your kitchen with those Euros. It's going under your mattress.

There's a lot of Euros getting stuffed into mattresses right now.

 
IlliniProgrammer:
Let's do a thought experiment here:

1.) If the ECB prints $3 Trillion in Euros and stuffs it in their walls, it has no impact on inflation. Or on the value of the Euro.

2.) If the ECB prints $3 Trillion in Euros, gives it to European consumers, and they promptly save it and stuff it under their mattresses, it has no impact on inflation or on the value of the Euro.

3.) If you hold Eurozone debt because you don't think the stock market is a good bet and don't want to spend money right now, having the ECB monetize your Spanish or Italian bonds doesn't necessarily mean you're going out and buying a new SUV and redoing your kitchen with those Euros. It's going under your mattress.

There's a lot of Euros getting stuffed into mattresses right now.

You're essentially making a balance sheet recession argument right now. Consumers' net worth has been eroded and this , when added to bleak future expectations , depresses consumer spending and creates a deflationary environment. The thing is - this applies equally to the US and Europe thus shouldn't really have that much bearing on the USD/EUR rate.

I can make the argument for further weakness in the Euro based just on the fact that the political decisions (country bailouts , EFSF like mechanisms, monetization etc) will either be taken by Germany or conducted under heavy German pressure. It is not in Germany's interest to have a strong Euro. It is not in Germany's interest to have a Eurozone breakup either. Thus we will see this continual dance , with a continuously weak Euro - along with as much German pressure on debtor nations as possible (but just shy of the amount that might make them consider leaving).

 
Bondarb:
I dont understand the question...EUR is one of the worst performing currencies in the World this year (even vs USD)...EURCAD, EURAUD, and many other crosses are at or near all-time lows. The EUR is indeed tanking.

Lol seconded.

OP, Have you even looking at the chart for eursek, eurmxn, eurzar, or even any of the other safe havens? I wouldn't be surprised if the ECB does a negative depo rate blue light special and we get some Weimar-esque outcome. xaueur long as well for those of you who live outside the US of A.

 
Bondarb:
I dont understand the question...EUR is one of the worst performing currencies in the World this year (even vs USD)...EURCAD, EURAUD, and many other crosses are at or near all-time lows. The EUR is indeed tanking.

If you take "Tanked" to mean underperformed, then yes, I agree with you. But from the context of the article its clear what I'm getting at is... What's keeping it from going lower? Why haven't we reached parity? Or... Why not go completely short euro vs. usd right now?

 
West Coast FX:
Bondarb:
I dont understand the question...EUR is one of the worst performing currencies in the World this year (even vs USD)...EURCAD, EURAUD, and many other crosses are at or near all-time lows. The EUR is indeed tanking.

If you take "Tanked" to mean underperformed, then yes, I agree with you. But from the context of the article its clear what I'm getting at is... What's keeping it from going lower? Why haven't we reached parity? Or... Why not go completely short euro vs. usd right now?

Not every trade is subprime in 2008 and we are in a low-volatility environemnt. Right now stuff just doesnt move 15% in a straight line...the market makes it a little tougher these days..

 
Best Response
Bondarb:
West Coast FX:
Bondarb:
I dont understand the question...EUR is one of the worst performing currencies in the World this year (even vs USD)...EURCAD, EURAUD, and many other crosses are at or near all-time lows. The EUR is indeed tanking.

If you take "Tanked" to mean underperformed, then yes, I agree with you. But from the context of the article its clear what I'm getting at is... What's keeping it from going lower? Why haven't we reached parity? Or... Why not go completely short euro vs. usd right now?

Not every trade is subprime in 2008 and we are in a low-volatility environemnt. Right now stuff just doesnt move 15% in a straight line...the market makes it a little tougher these days..

That's a legitimate answer. In other words, there are still EUR buyers out there. I'm simply speculating at who those buyers may be... And why they may be around longer than many had previously thought.

 

I don't think we're going to see a parity. I'd even say that we won't probably witness a 1.15 level either. At that point, probably the EMU is gone or on the brink of disintegration. Even at this level, whether the euro will persist is called into question. Any further depreciation will mean that the eurozone will be in a precarious state than now..

 

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