May 6, 2008

The Demise of the Euro?

This recent article by Avi Tiomkin at Forbes boldly predicts the demise of the Euro.

“It is only a matter of time, probably less than three years, until the euro experiment meets its end.”

“What will undo the euro: the mounting tension between the inflation-obsessed German bloc (including Austria, Luxembourg and the Netherlands) and the Latin bloc of France, Italy and Spain… Despite core inflation in the euro zone of only 2.4% and a slowing global economy, the Germans insist that the European Central Bank maintain a tight monetary policy. In direct opposition to Germany, the Latin bloc, joined by Ireland, wants the ECB to lower interest rates.”

Mr. Tiomkin rests his prognostication upon the apparently divergent needs of two “distinct” blocs within the European Monetary Union. As plainly illustrated above, he ascribes the need for polar and differing monetary policies for each bloc, which will ultimately sow the seeds of the Euro’s self-dismantling.

There is no doubt that “getting monetary policy right” for even one economy is a massive and unpredictable undertaking, let alone striking the perfect monetary balance for 15 diverse economies with unique and emerging economic conditions

One gets the feeling though, that there is an element of “wishful-thinking” to Mr. Tiomkin’s thesis.

“Along with the steep selloff that will precede the disintegration of the high-flying euro, other markets will be shaken. Look for much higher interest rates for prospective euro deserters like Spain and Italy as spreads for benchmark German bonds widen.

What should investors do? Gradually start to hoard dollars and short the euro. Another strategy is to sell investments in Italy and Spain and buy German fixed-income assets.”

There is no doubt that “hoarding dollars” at this particular point in time, is certainly contrarian investment advice in most precincts, and doing so would most certainly help out the battered US economy.

Although it appears that there are political and populist elements within Europe that are saber-rattling for change in the realm of monetary policy, it would be a rash move for Europe to undo the progress that it has made with the Euro since 1999.

“Launched in 1999, Europe’s single currency is now shared by 15 EU countries and around 320 million citizens, making it one of the world’s most important currencies and one of the EU’s greatest achievements.”

The current “crisis of confidence” in European circles in regard to the effectiveness of the Euro is perhaps more likely to lead to further integration between the states in question, rather than less, as Mr. Tiomkin suggests. The relative strength of the Euro globally is of course helping Europe in many ways too.

Perhaps most importantly, is that much of the current “brouhaha” in Europe over the value of the Euro is largely due to the continuing “exogenous shocks” caused by International economic forces outside of Europe’s control.

In today’s global economy we’re seeing a swift devaluation of the world’s reserve currency, resulting in a massive and simultaneous transfer of wealth from the USD to the rest of the world. This of course is the nature of the monetary policy beast, in the system that we have, set-up as it is. As this “shakeout” process in the US economy has progressed it has enabled the Euro to emerge as a safe-alternative currency for foreign Central banks to hold, outside of the USD.

Nonetheless, it will be more than interesting to follow this story as it emerges further.

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