25 June 2011

Is it the end of EURO?  VF answer:  Absolutely not.

The problems of Greece et al (lately also Italy is being mentioned) have raised a lot of questions over the future of Euro.  Various financial analysts and various commentators have been quick to kill the Euro off, interestingly even Roubini commented that “The Euro zone split is imminent” (and we usually tend to agree with the logic of Roubini – though not this time).  It is hence time for a good and honest analysis of this issue.

Current Situation

Back in February we compared the position of Germany to EU to that of China to the rest of the World;


where in essence China is keeping artificially low value of Yuan, at the expense of accumulating USD bonds, and similarly Germany is maintaining its productivity having been locked into EURO at the attractive rate – though luckily it did not accumulate any of the debt of the weak countries (well until now).  It is our opinion that neither of these will be willing to easily let go of this comparative advantage.

EURO is hence in a short run beneficial to everyone, Germany too.


What happens if EURO ends?

EURO break up would mean that a new Deutschmark would appreciate probably by some 50% vs the EURO basket, and probably by some 100 - 150% vs the weaker of the current EURO currencies, hence totally reducing German productivity, leading to unemployment and recession.   Secondly it would of course mean a default by Greece, Portugal, and half of European countries (at sovereign and at corporate level), as their currencies would depreciate, hence making the EURO debt problem even bigger and out of control.   If current Greek Debt to GDP ratio is 150%, should Drachma be reintroduced – that ratio could be even 300%, clearly ensuring a default, but the defaults would not be restricted to sovereign, and would include corporate sectors, mortgages, credit cards.  Furthermore this would not be restricted to Greece, and would include Ireland, Portugal, Spain, Italy, Belgium and most probably France too.

To add to this, all the losses of the banking sector in all other non bankrupt countries would mean, that somehow new equity injections would be needed, and I find it difficult to imagine where would these countries find hundreds of billions, if not trillions of EUROs to raise as equity.  Would it not be easier to continue to keep the banking sector alive on the live support called “accrual accounting”?

There is also an issue of global stability.  Just as I was very supportive of Hank Paulson to bail out pretty much anyone he has, as I believed that there was simply no other way out, I do think that Germans are in a similar position right now.  An end of EURO would not only mean hyperinflation in some countries, lack of cash coming out of the ATMs, corporate bankruptcies, but it could mean the end of the society as we know it.  Especially the “developed western” society is very much no ready for hyperinflation and barter trade, through ironically on the elasticity to Hyperinflation Greece would probably do well.



For these reasons, we do not think that the end of EURO is anywhere near its end, and in fact I would argue that during the recessions its need is bigger than ever.  Naturally, the currency will continue to weaken - though in the world today it is difficult to estimate which of the FIAT currencies is actually weakest.

Pretty much we can safly conclude that  EURO is simply too big too fail.


Next steps?

So for this reason the current status quo will continue, and EURO is not coming to its end.  If anything in time it might attract other weak currencies, as generally the weaker the country is, the more it benefits from EURO, and the only country that could potentially end it, Germany, will be afraid to do so as the costs of leaving EURO for Germany are immediate and short term, where as the benefits of leaving are only long term.  Furthermore, at some point, one currency concept is likely to expand further, to include other Global Currencies, in a replication of a Gold Standard.

Our view on other topics remains unchanged since we started our commentaries, and we do not feel a need to write about them every week.  Just to remind you, we remain bullish on commodities and Emerging Markets (both credit and FX), and remain bearish on Developed Currencies and Credit.  For Equities, it really depends on the specific name, but we generally took a bullish position sometime ago, mainly as a fight against inflation.  Equity is still real.  FIAT currencies and bonds are not.